“Cannot complete this action.” error when opening document library folder with spaces in its name

Are you using forms-based authentication? If so, make sure you have Service Pack 2 loaded, as it made some big changes related to Office Client integration. From TechNet: http://technet.microsoft.com/en-us/library/cc262201.aspx

If you have not installed Microsoft Office SharePoint Server 2007 with Service Pack 2 (SP2), client integration is disabled by default when you use forms-based authentication. This is because client integration does not natively support forms-based authentication prior to Office SharePoint Server 2007 with SP2. When client integration is disabled, links to client applications are not visible and documents cannot be opened in client applications; documents can only be opened in a Web browser. However, users can download documents, edit them in client applications locally, and then upload them to the site. If you have installed Office SharePoint Server 2007 with SP2, client integration client integration is supported for Word, Excel, PowerPoint, and SharePoint Designer authoring.

Actually, now that I think about it, the answer might actually be even easier. What happens if you navigate to the SharePoint drafts folder, open the document, and then check it in directly from within Word (as opposed to checking it in from the SharePoint UI)?

I have fixed the problem.

It seems to be related to the Record Center being created in the same Site Collection as the Collaboration Site that was created. When you create a new Site Collection and create the Record Center in there, the whole process works without a hitch.

So instead of sps2007/repository/, I have created sps2007/sites/repository/ and that fixed the problem.