That's an oversimplification. At one point, Sony (I believe it was Sony) got sued because it was selling VCRs. The argument was that Sony was selling a device that was being used to violate copyrights (ala, tape record TV shows). The court sided with Sony on the grounds that, although that use of a VCR might be problematic, the device itself served other purposes beyond copyright infringement. I think we can agree that an Xbox 360, even a modified one, can serve more purposes than playing copied games. Granted, I'm not nearly naive enough to think that most people aren't using it for that and that alone but the "infringing device" is really the modchip rather than the entire console. And in the case of software mods, well, that's another can of worms.
But nobody can come and actually take the entire system away. What can happen, and this is what happened to Lik-Sang, is the courts can go after people and companies selling modchips on the grounds that those devices don't serve a non-infringing purpose, unlike a VCR. Microsoft might be allowed to do what cable providers do and send a signal that renders the infringing hardware (the modchip) nonfunctional. In fact, firmware updates have been used to do things like that. But there are limits to what they can do. A cable provider, for instance, can't send a signal that not only fries the descrambler but also destroys the TV set it's attached to.
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