You can't upgrade your distribution lists (which are also known as distribution groups) to Office 365 groups.
This issue occurs if a custom email address policy is applied to the tenant for the Office 365 groups.
To resolve this issue, you have to remove the email address policy for the distribution groups. Then, try again to upgrade the distribution lists to Office 365 groups. For more information about how to remove the email address policy, see Remove an email address policy.
For more information about how to upgrade distribution lists, see Upgrade distribution lists to Office 365 Groups in Outlook.