This error occurs with an ambiguous error message. It does not show the line number of the source where the cause of the problem resides. This happened due to sass-rails dependency on sass gem. Since the sass gem was not declared in the Gemfile, the sass-rails upgraded sass gem to 3.4.4 which broke the application layout. By locking the sass gem to a lower version in the Gemfile:
gem sass, "~ 3.2.1"
The sass-rails picked up this version that works.