SIM card from carrier not supported under the activation policy?

I have an iphone passed down to me when the original owner upgraded. (its legal right?) I had my SIM card cut down size and now the phone tells me the SIM is not valid. The first owner was on contract with a company which is different to mine. Mine is EE. What do I do? I'm sure i'm not doing anything illegal.

You're not doing anything illegal but his phone is probably locked to one network. The only way to get it to work on a different network is to get the phone unlocked (jailbreak) and that can cost about £30-50. You could try doing it yourself and there's lots of forums about it, however, there's a chance you can brick the phone if you do it wrong. The choice is yours but the cost of getting it unlocked is cheap considering the value of the phone.