This was a decision long time ago and then I have followed this standard.
Here are some of the arguments as I recall them:
"Y" or "N" is more easy to understand than a bit column with 1 and 0.
For other string parameters (e.g., BackupType) using a non-max length could be a source of bugs, as the strings are automatically truncated. Because of that I standardized parameters and variables to nvarchar(max), and that also included the "Y" or "N" parameters.
It could be argued that a bit column is a more natural choice for the "Y" or "N".
Declaring a variable with maximum space, when the choices are binary
Hence, the choices will be "Y" or "N", why declare nvarchar(max) on these parameters?