I don't immediately see how the Army can prevent the release of the album, with or more obviously without "Diggers" as the album title. Presumably the songs are all covers and recording permission can be obtained through the usual collecting societies.

It sounds to me as if Warners are being dogs in the manger, refusing to release the album unless they are enabled to obtain some exclusivity in the use of that title (in which vein there are lots of exciting trade mark law issues presumably in Australia as here, and likely in the USA too).

I would be very wary if I were the Australian army of offering Warner any sort of exclusivity in relation to a term used to describe Australian soldiers (and indeed Australians generally) for I imagine about a century.