My OLD WD 250G HDD failed or is in the process of failing. Can't boot unless in safe mode.

So I have a New HDD installed on SATA1 and moved the old HDD to SATA2.

Planning on installing XP on the new HDD. Have created a new C: partition.

Should I complete the install without having the old HDD connected, connect the old after reinstalling windows and seeing if I can recover any of the data from it before I send it back (it is under warranty).

Yes, I would get everything loaded on the new hard drive before connecting the old.

Grumpy

I agree. I would copy everything off the old one and put it on your new one. Then i would install xp on the new one, keeping the old one unplugged.