In the example workspace there is a cross section seed DGN. The recommended workflow is to create a new DGN and reference the 2D model with live nesting so that the 3D model is also attached. Then use the create cross section tool which now uses the model drawing scale (ie. it does not use the scale factor in project options).
Regarding the odd dialog display, I think you may have used a upf from your old workspace. I'd suggest to setup your workspace for SS3 so that user preferences and system files are separate to SS2.