You could format it with NTFS after you get it set up (since FAT32 is bound to be a bit...slow with that much space). I imagine that everything would work fine with that large a RAID array, since the controller isn't actually seeing a single drive larger than 127MB, it's seeing your two 120 gig drives. However, it may be that due to the way it's having to map things for RAID, the controller will in fact not be able to deal with it. Interesting situation, can't hurt to try it. But you might think about checking with the controller maker and/or the controller chip maker and see what they say. They've hopefully tested that sort of configuration. The OS itself will work just fine with any size drive as long as the file system is capable. Wouldn't want to have to wait for a defrag on this setup though. 🙂
MMMm....two 120GB plus drive's RAIDed if it is possible. What the heck are you doing with that much space?