Yes, the generic.xaml need to be under Themes folder. So you need to add a Folder to your Silverlight project and name it Themes, and put generic.xaml in that folder. 

I'd prefer to add customer controls to my Silverlight Control Library project. So usually I have a main Silverlight application project which have my UserControls and App.xmal (application start point), and a Silverlight ontrol Library project which contains my customer controls (they usually do not have any business related code, and reusable through out all my applications).  If you choose to do it this way, add the Themes folder and generic.xaml to this control library project.