I would effectively like to switch from a case-sensitive journaled filesystem to that of a case-insensitive journaled filesystem. Booting into Lion's recovery allows me to format the drive as I wish, however, no matter what I choose Time Machine will always reformat it as a case-sensitive journaled filesystem (which makes sense). My question is, how can I make this switch?
The correct answer (after several days of experimentation) was to remove all ambiguously named files that would have a conflict. Then using another admin user, restore the original user using migration assistant. If you don't remove ambiguously named files, migration assistant will move what it can and then fail at some point giving no indication that it actually failed. You'll be without data and you won't know what.
You can restore from TimeMachine manually by opening Terminal.app and using
cp to copy the latest backup back to your main drive. Taking care of all the permission and metadata issues isn't for the faint of heart though (which makes it a bit difficult to provide a specific answer as well).