In SYSTEM.INI, the Windows Shell is defined as EXPLORER.EXE. When Windows reads this at startup, it searches for EXPLORER.EXE in C:\ first, and
then in C:\WINDOWS, which is the correct one. Normally, C:\WINDOWS\EXPLORER.EXE is thus used as shell, but if C:\EXPLORER.EXE is present,
that file is mistaken for the shell file. This 'bug' has been in Windows since the first release of Windows 95.
The Sub7 server as C:\EXPLORER.EXE probably runs C:\WINDOWS\EXPLORER.EXE too to prevent Windows from not functioning, but I wasn't able to check this since I didn't feel like rebooting.