We need to acknowledge character encoding and set some expectations. Much of this is taken from suggestions by SER (whom I don't otherwise know).
First, make header names required to be legal XML element names. This makes a lot of sense.
Second, specify the default encoding is UTF-8. This makes ASCII a nice subset for telnet purposes. Add an encoding attribute to the CONNECT and CONNECTED frames. The server should use the same encoding the client requested on the CONNECT, defaulting to UTF-8 if nothing was specified, but if the client requested an encoding which the server cannot handle, it must send back the encoding it will use to handle the session (assuming it could understand the CONNECT frame, of course =)