Hello @rajneesh kumar
Yes, your research is on-point.
The VM creation failure from the moc-operator is expected with the cluster being in ConnectionStatus: OutOfPolicy.
According to Microsoft, if an Azure Local (formerly called Azure Stack HCI) cluster has not successfully connected and synced with Azure for more than 30 days, the platform intentionally enters a reduced‑functionality mode. In this state, existing VMs continue to run, but creation of new VMs is blocked until the cluster returns to a healthy, connected state.
The positive takeaway is that this behavior is expected and by design. You are also already taking the correct approach by engaging Microsoft support and the product teams to help clear the OutOfPolicy condition and bring the cluster back to a connected state.
Once Microsoft confirms that the cluster has successfully re-synchronized with Azure, VM creation should work as expected.