For some reason one of our project collections was left in Install stata. Extended property TFS_SERVICE_LEVEL_TO was set to TFS2010.RTM but there was no TFS_SERVICE_LEVEL property defined in the database. We still can't figure out how project collection was left in the Install state in the first place.
Fortunately, we used broken collection as a playground so we can safely delete it since it does not contain any important data. Once we deleted probelmatic collection using TfsConfig tool we were able to perform upgrade to TFS 2012 Update 1 without any validation errors.
TfsConfig.exe delete {CollectionName}
If you run to the similar issue check SQL Server dababase extended properties using the following query to verify if team project collection database is broken
USE {Tfs_CollectionName}
GO
select * from sys.extended_properties
TFS_SERVICE_LEVEL property must exist and value for that property must be set in order to perform upgrade.