Really? I know Color Dreams was infamous for their poorly made unlicensed games, but I thought their activities were illegal.
As this relates to Atari: Atari lost against Nintendo in court because Atari copied the 10NES chip in its enitrety and included it in its games. Color Dreams had no such problems because they simply circumvented it, and there were no legal grounds (such as the DMCA) for Nintendo to effectively fight that approach in court at the time.
What's the purpose of the lockout chip if bypassing it has no consequence for the game's publisher?
Look at it this way:
On a long enough timeline, virtually all protection methods will be broken. The idea is to make that timeline long enough that there will be no value in eventually breaking it because the system that it was implemented to protect has no commercial value by the time that the protection is circumvented.
It's a form of insurance for the hardware manufacturer: it buys them enough time to recoup their hardware and software development investments, make money from software licensing, and turn a profit in the market.
Regarding consequences against pirates, bootleggers, or those releasing unlicensed software: any legal action would have to be financially worth pursuing and have a reasonable chance of bringing a victory in court. If those two conditions aren't likely to be satisfied, then other avenues (such as a cease & desist letter, or threatening to pull supplies of the original hardware and software from retailers who also carry bootlegs) may take place.
And, again, this is an issue that has changed substantially over the last three decades. In a lot of ways, it's still being dealt with today: see console hacking as an example.