Since there is alot of interest in the kit overlay feature, I will reply in general.
The overlay file is basically a transparent shirt texture, but with only the competition specific items drawn on. The game generates a new shirt texture placing the overlay file on top of the original shirt texture.
As shown above, while you can have a global kit overlay file for a tournament, you can create variants for individual teams. In this case, Liverpool would use a version with the badge of honour for five wins in UEFACL matches. This can also be used for sleeve patch positioning. You can also apply to individual kits.
This will be useful for career mode promotions, relegations and continental tournament qualifications. For example, Football League teams promoted to the Premier League can wear Premier League sleeve patches and captain's armband in Premier League matches.
There are references to this in the lua files so it is very likely that that file will be used. My best guess it is related to a flag holding character during trophy presentations. The flag to be used is the regular team flag file. I am unable to confirm this without the full game though.
Unfortunately, I do not think I can remove those flags as the lua files do not reference the flag model.