They won't sue as they can't really have much of a case since this would be classified as a cover and sounds nothing like the original material.
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Give it some time to cool down. Of course everyone is playing with it right now.
My guess is their lawyers made them include it just to cover their butts in case some record company is feeling particularly litigious. I highly doubt that SE is going to waste resources actively looking for people doing cover songs. As long as no one blatantly rips off a major artist and posts a recording of it online or something and then someone sees it and kicks up a stink about copywrite, I really don't see SE taking any action at all.
New feature implemented.... let the complaining begin! /sigh
They won't remove it. Other MMOs have this and had no copyright issues. Hell they don't even bother to action people who do use 3rd party songs, despite disclaimers saying they would. I doubt SE would either. It would take effort away from protecting people from parses.