Reaction of orthocresol with butyrolactone in presence of AlCl3 and heat
I can take a guess since no one else has provided an accepted answer.
First, I don't think lactones will take part in FC-acylation on an arene, but rather prefer alkylation as mentioned in this paper. In the case of o-cresol and heat, this could be a possible explanation for your question why the O-acylation takes place instead of the C-acylation.
Second, when the Fries rearrangement occurs, and the acylium ion is released in the intermediate, the phenolic oxygen is complexed with the aluminum chloride (second to last step here). If you imagine an ortho-methyl group, as well as the complexed aluminum chloride, it's plausible substitution to the remaining ortho-site is not sterically favorable. This would force it to substitute elsewhere on the ring.
As for why &quot;elsewhere&quot; prefers para to the methyl group and not the oxygen—going by what you wrote in your comment—I'm not sure. The para alumino-oxy substitution should produce the more stabilizing resonance structure for the arenium intermediate. At least, in one other reaction of electrophilic aromatic substitution with ortho-cresol, namely its nitration, the 3/5-nitro products are not found. Maybe it's a solvent matter. Wikipedia states a non-polar solvent prefers ortho in the Fries rearrangement; perhaps if the ortho site is blocked, it will settle for para to a methyl substituent.
Edit
In a summary of the comments, the m-hydroxy-ketone was called into question as the correct product. I mentioned none of the papers I found of similar reactions furnished anything but the para or ortho product. Here are the papers I looked through:
paper 1 - first paragraph: o-tolyl acetates yield predominantly p-hydroxy-ketones.
paper 2 - tables 2 and 3
paper 3 - table 1 (page 378)
paper 4 - 5th paragraph
A few others: book p 223, paper, paper