it must be a shapefile on disk...not in a GDB
start arcmap, add the shapefile
add the toolbox to Arctoolbox (not in ArcCatalog)
Run the tool, select the Layer (not the file on disk, aka don't select the folder icon but the black drop down arrow)
If that doesn't work, then you will have to send me screen grabs of your workflow to
Dan_Patterson AT carleton.ca (it seems that they have removed direct contact to individuals from the forums and/or scripts site)
In short, something about your workflow bothers me and it usually that people are running it from ArcCatalog or have their stuff in a geodatabase