The shortest code which can trigger this error is the following:

>>> import xmlrpclib
>>> print xmlrpclib.dumps(('\x01',))
<params>
<param>
<value><string>
</string></value>
</param>
</params>

As you can see, the escape method does not care about non-printable characters which can cause parsing error in the other side.

My previous patch used \x to tell to the other side that the value contains some binary garbage. It you want to reject these binary bytes (which was not acceptable in my case), use this patch:

--- a/xmlrpclib.py	2010-10-13 14:45:02.000000000 +0200
+++ b/xmlrpclib.py	2010-10-13 16:03:14.000000000 +0200
@@ -165,6 +165,9 @@
     return data
 
 def escape(s, replace=string.replace):
+    if (None != re.search('[\x00-\x08\x0b-\x0c\x0e-\x1f\x7f-\xff]', s)):
+        raise Fault(INVALID_ENCODING_CHAR, 'Non-printable character in string')
+
     s = replace(s, "&", "&amp;")
     s = replace(s, "<", "&lt;")
     return replace(s, ">", "&gt;",)

An other idea: we may use CDATA (http://www.w3schools.com/xml/xml_cdata.asp) to transfer binary values...