I don't think it's intended as a "solution", it just lets the clobbering that is caused by the case insensitiveness happen.
So git just goes:
- checkout content of README.md to README.md (OS creates README.md)
- checkout content of README.MD to README.MD (OS overwrites README.md)
If you add a third or fourth file ... it would just continue, and file gets checked out first gets the filename and whichever file gets checked out last, gets the content.