I don't know anything about the client backup service on SBS 2011, so I am not the one to answer this question. It looks as though you have found your answer.
My only question is if you wanted to delete the old client backups, could you have just formated that partition? Just wondering.
Also, your system drive has only 12GBs of space left on it. You may have to grab some space from the D:\ drive anyway. I started with 60GBs once. I had to change to 250GBs. I started getting nervous about updates, etc.
As far as backing up client backups with the server backup, I am not quite sure what your question is as the server is not a client. But, if you do a complete backup of your server, then it will also back up your client backups. You could exclude them, but for a bare metal backup, it may want you to image the entire server. With incremental backups, it probably wouldn't matter, but I have always wondered if each client backup were a new folder.
Glad you found your answer.