Its very unfortunate, that IE is treating DOM somewhat different then FF or other W3C complaint browsers. After implement drag and drop in FF found that everything was working great, accidentally client managed to check the same in IE and ofcourse droppable was overlaying draggable. After some googling i found the following ticket on rails track (http://dev.rubyonrails.org/ticket/2641 So I merely leaving a not for my self about what had worked for me.
Replace
Element.makePositioned(element);
with
if (!Prototype.Browser.IE) Element.makePositioned(element);
This will remove this functionality in IE. Whats sucks is that this ticket was opened 3 years ago, and bug is still there.
HOWEVER: I love rails.