I wasn't involved with the whole fan campaigning, so I'll just give my input from a developer standpoint.
About 4 and a half years ago, this same thing happened with our project. Everyone had an opinion. Some people wondered why it never happened sooner, some people wondered why it took so long, some people thought we deserved it, and some people thought it was just plain wrong. Regardless, it's one thing to be an observer and a completely different thing to have it happen to you.
Complying with the C&D is the best decision to start with. Do not, under any circumstances, attempt to undermine the law. We've had people suggesting us to change names & places, or post the release on peer-to-peer file-sharing networks. Needless to say, these actions are illegal, and while you may succeed in getting your game out to the fans, you will be held directly responsible for violating the C&D.
Now for what they should do. Firstly, I would strongly recommend Chrono Compendium to get into negotiations with Square Enix asap, if they haven't already. Explain to them why you do what you do, and show how your game will not negatively impact their company. Allow them to fully evaluate your game, and be sure to emphasize how it will improve their goodwill by allowing your game to be released.
The other thing I noticed after visiting their site is how committed they are to keeping the game non-profit, to the point of not even allowing Paypal donations or even advertisements on their site. We're the exact same here. And personally, I think that's also your strongest defence. The existence of your game does not syphon away profits from Square Enix, nor does it damage their reputation, or dilute their brand. On the contrary, your work actually helps to attract more fans to their company, which in turn purchase their products and keep their business afloat.
Once you can fully convey that message to their lawyers, so that they see things from your perspective, they may reconsider. Just remember that you are now fully accountable and are being highly scrutinized for any decisions you make from this point onward, due to all the press & fan attention. You have a lot of power there, so be sure to use it responsibly.