2. He may disband to the draw pool.
We can't find anywhere in the rules where the second option is specifically stated though there is a reference to him being in the draw pool I think.
Do these rules also apply to the king (substituting Fife w/ no health bump for Selkirk)?
It might depend on which rules version you have. In the version 2.3 rules it's covered in a somewhat roundabout fashion. For example, rule 5.8 states:
5.8 ELIMINATED BLOCKS
EXCEPTION: When eliminated in Battle, blocks with a black cross (see sidebar) are permanently eliminated. All blocks eliminated as a consequence of the Pillage Card, Border Raids, or Winter Attrition are disbanded to the Draw Pool.
Then in 7.5 you have:
7.5 SCOTTISH DISBANDING
The Scots player now disbands all blocks that exceed an area’s Castle Limit. The Scots player may choose which block(s) to disband. With the exception of Moray, a Noble cannot disband.
All blocks exceeding the limit disband, Nobles cannot disband, Wallace isn't a Noble, thus he disbands. I think the combination of these two covers both the Wallace and Scottish King situations you mentioned.
An April 2007 thread on the Columbia forum also addresses this topic.