You cannot group by XML or TEXT columns, you have to first convert it to varchar(max).
Try:
SELECT
TOP 1000 [AccountsPayable_Content].ItemID,
[AccountsPayable_Content].C2SID_SUBJECT,
[AccountsPayable_Content].C2SID_CREATOR,
[AccountsPayable_Content].C2SID_DATE,
[AccountsPayable_Content].KEYWORDS,
CASE [AccountsPayable_Content].C2SID_Notes
WHEN ISNULL(CONVERT(xml,CONVERT(varchar(max),[AccountsPayable_Content].C2SID_Notes)) NotesXML)
THEN
"0"
ELSE
"1"
END,
[AccountsPayable_Content].LastName"
FROM
AccountsPayable_Content
Details here:
Limitations of the xml Data Type[
^]