You should do a *almost* clean install. You don't have to format your entire disk, but you do have to format that system partition. Even though your other files shouldn't be touched, I would back them up anyway.
Follow this tutorial, but instead of formatting your entire hard drive, just format the partition that Vista was located on. Clean Install Windows 7
I believe that should work properly. If it doesn't, you can always do a real clean install after backing up all of your files on those other partitions. If you need a decent partition manager Partition Wizard
is free and works well.
As far as your worries about the "upgrade" portion, you don't have to worry about this. As long as you wait until the operating system is installed to enter your cd key you can perform a clean installation (on a formated partition).