1. Clicking on the “Image” upload option under “Add New Post” or “Add New Page” screen
2. or by clicking on Media, and then “Add New” from the new WordPress 2.7.1 menu option
3. or by using the “Custom Image Header” option that many of my themes provide.

I was very much puzzled and I tried to solve the issue by taking different approaches.

The First Approach
The first approach I took, was to check permissions for the “wp-content” and the “uploads” directory within the WordPress installation.
I even set it to “777″ which basically means “open” to anyone. (by the way, 777 reminds me of the coupon code of DreamHost which offers a heavy discount on their hosting package.)
Anyway, coming back to the point, the permission changes did not help.

The Second Approach
The second approach is to see if any of the plugins is causing this issue. I went to the Plugins area and disabled all the plugins.
I tried uploading an image afterward, but still no luck.

The Third Approach
Third approach does not take a lot of thinking to do. It is just “Ask the Google” approach. After skimming through a couple of links, I finally landed on this thread on the WordPress.Org forums.
and at the bottom of page, I saw this comment.

Solution for the error
Step 1: Log into your admin panel
Step 2: Go to Settings>>Miscellaneous
You will see two options,
Store uploads in this folder
Full URL path to files
Most probably you will see
/home/.boogee/XXXXX/XXXXXXX/wp-content/uploads
in the first field.
Step 3: Edit that to just
wp-content/uploads
PS: Please take a backup of what you are editing, in case this trick didn’t work, you can restore the old URL.
This should do the trick.

I tried to manually set it to “wp-content/uploads/” but it still did not work for me.

Then finally, I just went ahead and emptied the text on those text boxes and saved it.

Click for a larger view!
Anyway, This fixed the issue for me and hope it stays fixed when upgrading to the next version of WordPress.
Disclaimer: This post is only given as a suggestion, and please don’t make me responsible if it does not work for you.