Do they games have to be installed before digital license option is available?

When you purchase a digital game, it'll then ask you to install it. In this case, you'd just put the disc in instead & install it that way. Once that's done the OP chooses the digital install option, which will take only seconds to install his licensing
info since all the other files are already there. Essentially he'll have the game + his license + his friend's license (from the disc) all on his console.

That game is no longer available to purchase through Live. Not all 360 games are available digitally and many arcade games have been delisted after a while due to licensing issues or just lack of sales. If you see a game without a purchasing option, then
it is not available.

The game is not available at my own region and it appeared at games ready to be installed after inserting the game disc.

So the digital license appeared again and I tried to see if it’s still work.

But now I fear that using the digital license at the second account violated the terms and conditions.

You would have to purchase them digitally in order to be able to play them. Otherwise, you would need the disc in order to prove you have a license for the games. If you do purchase them digitally, you don't have to re-install them, but there will probably
be an install for licensing.

Hello Chaos,

Sorry for the issue with your game. Try uninstalling the game and DLC completely and install it from the disk.
Have you made sure all the DLC content is installed? Also, if you installed all the content digitally, why do you own a disc? This may be causing the issue. Since you have all of it installed digital, if it is just the normal game not legendary. For
example The disc license is for legendary, the digital license is for the regular game.

Thanks,

Brad