How open is open source Android?

I have found the Android project to be interesting to follow. There have clearly been some successes in using open source for product development (Linux, obviously but also Apache). The success of open source seems to be a bit uneven; for example, I am not aware of a huge development community around Solaris, which was open-sourced by Sun. So when Google launched Android as an open source development project, I was most interested, especially given Google's market clout and user following.

So this item really caught me by surprise. I especially found this paragraph interesting (and a bit counter-stereotypical):

Google, however, appears to be significantly less permissive on this front than Microsoft. The company's legal department objects to the Cyanogen mod on the basis of its inclusion of Google's proprietary software. They sent Kondik a cease and desist order compelling him to remove the mod from his Web site. The Android enthusiast community has responded fiercely, condemning Google for taking a heavy-handed approach. Even Google's own Android team appears to be frustrated with the legal department's zeal.

I fully expect that some bright and committed programmers will find a work-around. The whole reason for the mod, of course, is that Google's ROM doesn't work as well. Isn't that how open source is supposed to go? Has Google discovered the hazard of this approach? I wonder if they'll encounter similar problems when Chrome OS goes open source?