Thank you for the help, Victoria...
I sent an email to the home office outlining that we were seeking secretrary of state permission for our situation. They sent us the MN1 form and told us to list "illegitimate child of a British citizen father". We are meeting with the citizenship officer in Hatfield on Wednesday (who for a fee of £20 will review the paperwork, send it to the home office & review our documentation so that we do not need to send off our passports!)
I will keep you updated (if you are interested!)
As far as the new law, the Nationality, Immigration and Asylum Act of 2002 section 9, regarding illegitimacy, it has not yet gone into practice... so this MN1 option (and secretary of state permission) is the only one currently available for us...