My issues goes like this:
1. Server is running RHEL 6.4. Installed proftpd and configured it to start at port 2222. DefaultRoot ~sftpuser,!users (set default chroot directory). Everything is configured as per my company need.

2. comment out following lines from /etc/ssh/sshd_config
Subsystem sftp /usr/libexec/openssh/sftp-server
Subsystem sftp interal-sftp

3. created separate file system and mounted at /home/sftpuser.Now all sftpuser will be inside /home/sftpuser. Below are directory permission
drwxrwxrwx. 5 root users 4096 Jun 25 21:24 /home/sftpuser/
created directory inside /home/sftpuser for user maxsftp with permission as:
drwxrwxrwx. 2 root users 4096 Jun 25 20:47 maxsftp

4. Added user ‘maxsftp‘ with following line directly copy pasted to /etc/passwd (not used like useradd –d /….. so on)
maxsftp:x:706:51::/home/sftpuser/maxsftp:/sbin/nologin

and copy pasted following line to /etc/group
sftpuser:x:51:maxsftp

5. set password for user with #passwd maxsftp
Now when I perform following task to test sftp , got following error

a) [root@server1] # sftp –oPort=2222 maxsftp@server2
Connecting to server2...
maxsftp@server2 password:
Permission denied, please try again.
maxsftp@server2 password:
……

(server 1 and server 2 both running proftpd daemon and sftp occur at 2222)

Help is really appreciated…

Try inspecting the log files as for why the password failed

For the time being: i performed to test sftp in localhost

#sftp maxsftp@localhost -p2222
maxsftp@server01's password:
subsystem request failed on channel 0
Couldn't read packet: Connection reset by peer

here are the logs:

root@server01:~# tail -f /var/log/secure

Jun 27 10:06:01 server01 sshd[28918]: Did not receive identification string from 10.239.30.1
Jun 27 10:06:01 server01 sshd[28918]: Did not receive identification string from 10.239.30.1
Jun 27 10:06:01 server01 sshd[28918]: Did not receive identification string from 10.239.30.1

root@server01:~# tail -f /var/log/messages
Jun 27 10:07:13 server01 proftpd[28966]: 10.239.61.111 (::ffff:10.239.30.1[::ffff:10.239.30.1]) - SSH2 session closed.
Jun 27 10:07:15 server01 proftpd[28967]: 10.239.61.111 (::ffff:10.239.30.1[::ffff:10.239.30.1]) - FTP session opened.
Jun 27 10:07:13 server01 proftpd[28966]: 10.239.61.111 (::ffff:10.239.30.1[::ffff:10.239.30.1]) - SSH2 session closed.
Jun 27 10:07:15 server01 proftpd[28967]: 10.239.61.111 (::ffff:10.239.30.1[::ffff:10.239.30.1]) - FTP session opened.

root@server01:~# tail -f /var/log/proftpd/sftp.log
Jun 27 10:50:45 mod_sftp/0.9.7[30647]: disconnecting client (received EOF)
Jun 27 10:50:48 mod_sftp/0.9.7[30650]: using '/etc/ssh/ssh_host_rsa_key' as RSA hostkey
Jun 27 10:50:48 mod_sftp/0.9.7[30650]: using '/etc/ssh/ssh_host_dsa_key' as DSA hostkey
Jun 27 10:50:48 mod_sftp/0.9.7[30650]: disconnecting client (received EOF)
Jun 27 10:50:50 mod_sftp/0.9.7[30651]: using '/etc/ssh/ssh_host_rsa_key' as RSA hostkey
Jun 27 10:50:50 mod_sftp/0.9.7[30651]: using '/etc/ssh/ssh_host_dsa_key' as DSA hostkey
Jun 27 10:50:50 mod_sftp/0.9.7[30651]: disconnecting client (received EOF)


Any suggestion...

- Why didn't you just use useradd and chose to copy paste user info in the /etc/passwd directly?
- have you got selinux disabled? (hopefully not, but you could try 'setenforce 0' temporarily t see if it changes functionality).

Are you planning on using password authentication or publickey authentication? with the latter, realize the key has to have a specific format:
This did the trick for me, following this page: https://www.digitalocean.com/communi...instead-of-ftp

For password authentication, the SFTPAuthMethods set to password should suffice.

I noticed though, that the DefaultRoot should have no comma seperated values or the authentication fails. use a space instead.

That made it possible for me to get it working.