The choice of code L or code M is not optional, it's dictated by the circumstances. Since you did not default before separating from service with this employer, the loan should be satisfied with an offset distribution, code M, and should not be treated as being in default subject to a deemed distribution, code L. Offset distributions are eligible for rollover, so contact the employer to resolve the error in their instructions that indicate that the distribution is not eligible for rollover (implying that they will be incorrectly reporting a code-L deemed distribution).
The difference in the circumstances is that after separation from service you are permitted to make distributions whereas before separation from service you are not. If you were still working for the company and defaulted, the loan becomes taxable but is not satisfied, and you are still required to repay it.
