Bo, this is a known problem. From the fix's readme:

   This is FIXTEST Version 1.1.2.01.  It includes the following fix:

   -  IC26111

      If a SQL Server 7.0 database is at compatibility level 60 or 65, an
      attempt to backup the database or its transaction log would result
      in the DB-Lib message "Incorrect syntax near the keyword
      'database'" and the backup would fail.  This no longer occurs.
      Databases at any compatibility level can now be backed up
      successfully.

The fix is available at:
ftp://ftp.software.ibm.com/storage/tivoli-storage-management/patches/agents/ntsql/1.1.2/

Bob King    IBM Global Services
bobking AT us.ibm DOT com