Per the note/settings in the Xoom:
Setting > Location & Security > Encrypt tablet
"You can encrypt your accounts, settings, downloaded applications and their data, media, and other other files. Once you encrypt your tablet, you must enter a numeric PIN or password to decrypt it each time you power it on; you can't unencrypt your tablet except by performing a factory data reset, erasing all your data.
Encryption takes an hour or more. You must start with a charged battery and keep your tablet plugged in until encryption is complete. If you interrupt the encryption process, you will lose some or all of your date."
After reading this I can understand why they will require it encrypted before the do an upgrade, they are protecting the owner of lost/stolen data during transit/upgrade.