Both issues trace back to running on non-serverless compute. Community connectors were designed to run on serverless Spark Declarative Pipelines (SDP), and serverless is on by default in the CLI config for a reason.
The No module named 'databricks.labs' error happens because the pipeline relies on root_path (set to the repo's src/ directory in the workspace) to put databricks.labs.community_connector on the Python path. That root_path mechanism is specific to serverless DLT. On classic/non-serverless compute, that path isn't added automatically, so the import fails. Adding sys.path.insert in the notebook itself can work as a workaround, but only if you point it at the correct workspace path where the repo was cloned, like:
import sys
sys.path.insert(0, "/Workspace/Users/<you>/.lakeflow_community_connectors/<pipeline_name>/src")
Make sure that path matches where the pipeline's repo was actually checked out (you can find it in the pipeline's notebook location or the Workspace Files browser).
The UNSUPPORTED_LANGUAGE error for the generated Python notebook is a separate quirk. The Lakeflow Connect UI generates the pipeline notebook in a format that gets flagged as unsupported when serverless is off. Your workaround of manually recreating the notebook is the right call for now. The "Default file format for notebooks" setting doesn't affect auto-generated pipeline files, which is why changing it didn't help.
The cleanest path forward, if your network constraints allow it at all, is to use serverless compute. Community connectors just aren't tested or supported on classic clusters, and you'll keep running into friction. If you're blocked on serverless due to a private network/VPC requirement, you'd need to set up a private endpoint for serverless compute, which is a workspace-level network config, not something you can work around in the pipeline itself.