Solved issue #2 (the xcopy problem), and it was coincidentally connected to issue #1 (space in build cloud name).
So, when experimenting with the setting just mentioned Build Environment->Images->Add Image->Add Build Worker Image -> build cloud, this got set and unset during the testing. Finally at the end, it was left unspecified.
When you don't specify the build cloud, it defaults to the main settings default, which is the Process cloud.
So, builds were not running on the docker cloud, they had shifted to the Process cloud which lacks xcopy. Adding the build cloud name back is one way to solve it, of course another way is to adjust the build cloud setting elsewhere such as in the project, etc. So, it is fixed.