I'm having a similar issue with this quest. Only that I had killed the baron's men and later received the red failed journal update.
Below is a long explanation of what exactly happened, which I already submitted to support as per an earlier suggestion along with a save game:
The quest "The Nilfgaardian Connection" updated with the line "Defeat the baron's men" as red failed when I was already past that point and in Heatherton in Hendrik's hut, during the first quest update, that happens in that hut right after examining Hendrik's body and getting an update to Hendrik's character entry. I did defeat all of Baron's men at the Inn at the crossroads earlier though, except perhaps the one bandit that seemed to have asked a villager about hidden pigs and entered the villager's hut that afterwards had a locked door.
EDIT: I did count 6 dead bandits after, so it seemed the one who entered the hut came out to fight as well.
While I was at the "Inn at the Crossroads" I chose to drink with Baron's men who were labelled "bandits" and in the dialogue options I did not choose to insult them. I asked them questions during the timed drinking dialogue and it ended peacefully. Then the quest updated into the stage "Finish talking to the innkeep about the agent called Hendrik" during which the innkeep moved away from the counter to the other part of the inn. I saved at that point and watched as the Baron's three men, with whom I just had a peaceful drinking dialog, remain seated at the inn table. I listened to their conversation and found out that one of them had raped some villager's son or daughter.
I then walked out of the inn and saw the other three Baron's men labelled as "bandits" talking to villagers at three separate huts. One was checking on pigs and the other asking about a potential hidden daugther and a third about loot. Two of the bandits then walked back to their carriage infront of the inn.
At this point I decided these bandits do not deserve to live and went back into the inn to talk to the three "bandits" still seated at the table. I talked to the bandits twice. Pressed "E" etc. after which they became hostile, after which Geralt killed the three in the inn and the other three outside. I then proceeded to talk to the innkeeper, who after the dying bandit on the floor cutscene, said "Have you any idea what the baron'll do when he learns of this butchery?!" The conversation ended with the innkeep telling me about Hendrik and asking me to leave through the back door "Go out the back. More o' the baron's men in the village." At this point I had killed all the 6 "bandits".
I left the inn area to a nearby "?" that was a bandit camp and came back after which the innkeeper talked to me about Bloody Baron etc. and was willing to trade etc. I then proceeded to Heatherton and while in Hendrik's hut after examining his body the red failed line "Defeat the baron's men" appeared in the journal.