I have this issue as well.
When my series 3 (OS7.2) watch and AirPods 2 are connected to my iPhone 12 Pro max (14.3), my phone constantly freezes and I can not play audio through the AirPods. When I shut down my watch, everything works normally. I have factory reset the AirPods, reset the watch, hard rebooted the phone several times and still nothing. This started for me the day after updating my watch to OS 7.2.
also, when I have the watch connected and then I take AirPods out of case for use, they show connected via Bluetooth but I cannot select them as output in the airplay menu within control panel. I tap “AirPods”, loading spin animation for a few seconds, then it just selects my iPhone speaker again. No way to even use them with watch connected. Extremely frustrating since Apple equipment is not cheap. Hoping apple fixes this issue in either a watch update or iOS update, whichever is the root cause.