The correct answer to the issue is as follows. Dave.Mishchenko's answer works but it does not address the core problem.
The issue is that you MUST create the new scratch folder PRIOR to changing the ScratchConfig location.
So if you already had a scratch location of '.locker' folder for example, and wanted to move it to a new folder called 'scratch' you would have to create the NEW folder first by browsing the datastore, and then add the path under the advanced setting ScratchConfig as follows:
/vmfs/volumes/datastore/scratch
Then reboot to action change.
An additional note to this is that on a fresh install of 5.5.0 update1 to SD card the scratch location does not get set up correctly, and one will see the error: No scratch partition has been configured. Recommended scratch partition size is {} MiB
The way to fix this is to do as Dave.Mishchenko wrote. Just move the scratch location to the root of the datastore.
It means you'll end up with lots of new folders in the root, but this is the only way to fix this bug in 5.5.0 update 1.
example:
ScratchConfig location: /vmfs/volumes/datastore