HTTPS client and server app results in SEC_E_INTERNAL_ERROR (0x80090304) when server requests client cert and client uses imported PEM cert

Question

Our Schannel implementation of an HTTPS client and server app in C, during SSL handshaking where server is requesting a client certificate via AcceptSecurityContext passing in ASC_REQ_MUTUAL_AUTH and client is providing a x509 certificate with RSA key (blobs imported from PEM file). This results in a client failure during the second call to InitializeSecurityContext with SEC_E_INTERNAL_ERROR (0x80090304) - The Local Security Authority cannot be contacted.

NOTE: This same logic works without failure when same client certificate is provided by the Windows Certificate Store.