Finally I figured out what had happened. When you fill XML for cloning request, order of <files> elements is really important. I know it weird, and it took me around a day to troubleshoot it. XML spec do not cover it also.
NB! Configuration File <files> section should go before VMDK <files> section. If it is not, it will fail with meaningless error.
Just want to let you know i'm working on something similar but will be using powershell to invoke the soap request. In the process of trying to develop powershell functions that interact with the web services API (just need bit more information from the VSC developers). Note that the VSC methods and properties are exposed to web services, here is an example: