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When using one SSH-2 server, identifying itself as "1.36_sshlib GlobalSCAPE", PuTTY reports "Incoming packet was garbled on decryption". This was originally reported as a bug in FileZilla, and turns out to be a bug in the server.
When PuTTY opens the data channel for the SFTP session, it sends SSH_MSG_CHANNEL_OPEN, and states a window size of 0x7FFFFFFF (2147483647) bytes but a maximum packet size of 0x4000 (32768). That is, the server is permitted to send almost any amount of data without requiring an SSH-level acknowledgment from PuTTY, but may not send an individual packet larger than 32768 bytes.
The server is disregarding the specified maximum packet size, and is sending a packet of 65548 bytes. PuTTY treats this as a decryption failure, since the most common reason for the packet length to be out of range is because there was a disagreement in the bulk encryption between client and server, causing the packet length field to decrypt to random garbage data. In fact that isn't the cause of the problem in this case, but PuTTY unfortunately can't determine that by itself.
This appears to have started happening as of r7672 in the PuTTY source base, which is when PSFTP began presenting a window size larger than its packet size. Prior to that, this server would not have generated too-large packets because it was honouring the window size limit. However, it is the server which is behaving incorrectly; PuTTY's change in behaviour is entirely legitimate.
PuTTY now detects this particular server software and limits the window size it advertises in order to work around the problem.
Update, 2008-07-19: according to this thread, another server with a subtly different version string has the same problem. As of today's snapshot PuTTY should automatically detect that version as well.