I had more than 1GB but less than 3GB of free space on my iPhone 4 when I began the upgrade to iOS 5. The upgrade went OK, but the restore process after the upgrade went awry. And, in a most un-Apple-like manner, the dialog box is less than helpful. :(
"Continue Restore" just repeats the restore, and I got the same error. No joy there.
I opted to Google the error code . . .
There is a thread going in Apple Community Support that is more helpful than Apple's official support document regarding these sort of errors.
To avoid the error, it seems that I would have been better off reconfiguring my iPhone BEFORE attempting the upgrade. As that is what I was effectively forced into doing in the end anyway; and doing so would have saved at least an hour. In my case, the solution would have been just removing all music from the phone; as I have had to restore it all anyway.
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