Thanks for your thoughts Al.
My responses are listed under you points below.

1. http://support.microsoft.com/kb/978869 . Not exactly what you're seeing but it might be worth testing.
I had found this also, but it does not seem to apply because the application will run it just fails when it tries to make a SQL Server connection.

One of my support techs requested the fix from Microsoft however they have not sent it to us yet.

2. Antivirus - can you temporarily test with real-time scanning disabled on both workstation and server?

There is no antivirus on the server. I tried disabling it on the workstation and there was no difference.

3. Ancient trick - sometimes marking an .EXE on a network share as read-only can fix strange issues

Tried this, no difference.

4. On the MS SQL server computer, is the SQL Browser service allowed through the firewall (as well as the SQL Server service itself)?
I use IP addresses and port number specifically so I (and my customers) can turn the SQL Browswer Service off. It is only used to find out what port number a particular instance of SQL Server is listening on and if you specify that in your connection string the SQL Browswer

Service is not needed.

5. A Win7 workstation talking to a Server 2008 server will, by default, use SMB2. An XP workstation does not know about or support SMB2, so it uses original SMB (aka SMB1). For a test, you could try disabling SMB2 on just a Win7 workstation per http://www.petri.co.il/how-to-disable-smb-2-on-windows-vista-or-server-2008.htm .

I tried this on the workstation side and it did not make any difference. It is something new that I was not aware of.

As a workaround I did write a very short FoxPro EXE that can be run from their worstation and takes the path (as a command line argument in a shortcut or in a confguration file) to the original shared folder and that works.