Right, so you're trying to restore image made on 320GB->120GB...if that is the case (if I remember correctly) the reason it won't run is because you can only restore to a HDD the same size or bigger using Win 7 Backup and Restore...(if this is incorrect, I'm sure somebody will correct me).
I would try another software, like the trial version of Acronis True Image, Clonezilla, or if a Seagate HDD, then DiscWizard, if Maxtor, Maxblast, if WD then WD Acronis TI...