It says I need to use %C1 & %C WPS tags [...]
That first tag should be %Cl, not %C1. The WPS parser would probably choke on the WPS file syntax and default to the old built-in theme.
Also, from the Wiki page:
The order of priority is the following:
1. ./ filename .bmp - same filename as currently playing music file
2. ./ albumtitle .bmp - name of the album, found in metadata of the music file
3. ./cover.bmp
4. /.rockbox/albumart/ artist-albumtitle .bmp
5. ../ albumtitle .bmp
6. ../cover.bmp
There's nothing in there about using the folder name as a valid album art file name. You can, however, use the album title as found in the metadata tags for the songs, or, since it's stored in the same folder, just name it cover.bmp.