I suspect that there are other values in addition to 'true' and 'false' in the field 'Flag1'. So check for the values in Flag1.
select distinct Flag1 from YouTable.
Here is my proof:
declare @Flag varchar(25) = 'False'
select CONVERT(Bit, @Flag)
It works fine.
However, this will give the same error.
declare @Flag varchar(25) = ' False' -- Pay attention to the the space in ' False'!
select CONVERT(Bit, @Flag)
-> Msg 245, Level 16, State 1, Line 2
Conversion failed when converting the varchar value ' False' to data type bit.
Pay attention to the the space in ' False' in the error message!