AR 635-200 1-32 and AR 135-178 are considerably different. See, AR 635-200 para 1-32 and AR 135-178 para 1-8. A reservist that gets diagnosed with an unfitting condition gets a chapter 6, convenience of the government discharge. That is why the LOD is so important, it brings them into the realm of 635-200. There is no discharge authority, while in a reserve status and subject to AR 135-178, for a disability retirement. See 10 USC 1201 and 10 USC 1204.
If they collected active duty pay after discharge, I agree that would be clear. However, if they changed their status, it would have been the government's booboo, a defective enlistment back into the reserve, and hence no pay should be collected. Changing the nature of the discharge doesn't make the reserve time impossible, just invalid, and a government booboo. If the injury occured in an activated period in 07, then they were activated again in 09, again, government booboo, and the discharge should be effective on the end of the 09 period.
I agree the DD214 would probably need to be corrected by the ABCMR, but the service secretary has the authority to direct other means to correct the discharge being incorrect. Ultimately, its that active duty discharge that is being declared FUBAR by the PEB, the REFRAD was incorrect and they should have been given disability retirement at the time the DD214 was cut. The LOD says it was active duty time the injury was incurred and you cannot be removed from active duty status without the correct discharge, which failed to happen.
DD214 is for an active duty period. That is its definition. A medical discharge w/ retirement pay or separation pay is for an active duty period, that's its definition too.
I understand you know a great deal about this stuff Ed, and I am very hesitant to disagree with you. From what I understand though, the military is wrong if they are not correcting these DD214s. The only times orders would be sufficient is the 3 exceptions in AR 635-40 para 8-2 for active duty periods not warranting a DD214. I don't necessarily know if there is a driving need to correct the DD214s if the orders are being sufficient to get everything done, but ultimately the stated goal of maintaining accuracy of military records is not being accomplished, IMO. I'm perfectly willing to be wrong on this though.