"No te veía esa noche."
I can imagine some situation in which the "I was not seeing you that night" might be appropriate, but it does seem pretty stilted.
Yes it is, you just got it wrong.
"I had arranged to see Brynhild that night. Therefore, I was not seeing you."
Your example makes sense to me. Until I read it, I was thinking the correct answer was absolutely horrible.... but now I'm ok with it.
On Google, exact match...
"I was not seeing you that night" - 1 result (DuoLingo: this page)
"I wasn't seeing you that night" - 0 results
"I did not see you that night" - 3 results
"I didn't see you that night" - 17 results
No, sorry, but even with the qualified, we still wouldn't use this. We would say I did not see you. We would not even use it with the usual "when I ......" It is just incorrect English. In your example, I was not going to see you would be acceptable.
By itself this doesn't work very well and it's misleading to teach it in Spanish too because I'm pretty sure the preterite would be more appropriate here.
I think to make sense of this sentence you have to think of "seeing" not in the vision sense, i.e. looking at you, but rather in the "going out" sense, i.e. "I was not going out with you that night." Still seems a bit stilted even then, as I would probably say " I did not go out with you that night." But, as we're clearly discovering, language, any language, is not cut-and-dried when it comes to usage.