What do the rules say about an illegal move OTB?

So its the last round of a rapid OTB tournament. Winner gets $100, loser at best ties for 2nd at splits $50 with other players. Here's the position:

 Here, not noticing the pawn in the way, my friend playsd Bxb7!! His opponent, disgusted that he could have missed such a move, tips over his king and resigns! Only then do they realize the error and go back to the position.  What's the official rule here?  Could he have claimed a win?

Resignation ends the game. Your friend could claim a win.

An illegal move doesn't end the game unless otherwise stated before the tourney starts by the TD... this "house rule" is usually only for blitz games, not rapid games.

Seems unfair to me.