diff --git a/mercurial/copies.py b/mercurial/copies.py
--- a/mercurial/copies.py
+++ b/mercurial/copies.py
@@ -170,11 +170,17 @@ def mergecopies(repo, c1, c2, ca):
     Find moves and copies between context c1 and c2 that are relevant
     for merging.
 
-    Returns two dicts, "copy" and "diverge".
+    Returns four dicts: "copy", "movewithdir", "diverge", and
+    "renamedelete".
 
     "copy" is a mapping from destination name -> source name,
     where source is in c1 and destination is in c2 or vice-versa.
 
+    "movewithdir" is a mapping from source name -> destination name,
+    where the file at source present in one context but not the other
+    needs to be moved to destination by the merge process, because the
+    other context moved the directory it is in.
+
     "diverge" is a mapping of source name -> list of destination names
     for divergent renames.
 
@@ -183,16 +189,16 @@ def mergecopies(repo, c1, c2, ca):
     """
     # avoid silly behavior for update from empty dir
     if not c1 or not c2 or c1 == c2:
-        return {}, {}, {}
+        return {}, {}, {}, {}
 
     # avoid silly behavior for parent -> working dir
     if c2.node() is None and c1.node() == repo.dirstate.p1():
-        return repo.dirstate.copies(), {}, {}
+        return repo.dirstate.copies(), {}, {}, {}
 
     limit = _findlimit(repo, c1.rev(), c2.rev())
     if limit is None:
         # no common ancestor, no copies
-        return {}, {}, {}
+        return {}, {}, {}, {}
     m1 = c1.manifest()
     m2 = c2.manifest()
     ma = ca.manifest()
@@ -206,6 +212,7 @@ def mergecopies(repo, c1, c2, ca):
 
     ctx = util.lrucachefunc(makectx)
     copy = {}
+    movewithdir = {}
     fullcopy = {}
     diverge = {}
 
@@ -315,7 +322,7 @@ def mergecopies(repo, c1, c2, ca):
     del diverge2
 
     if not fullcopy:
-        return copy, diverge, renamedelete
+        return copy, movewithdir, diverge, renamedelete
 
     repo.ui.debug("  checking for directory renames\n")
 
@@ -352,7 +359,7 @@ def mergecopies(repo, c1, c2, ca):
     del d1, d2, invalid
 
     if not dirmove:
-        return copy, diverge, renamedelete
+        return copy, movewithdir, diverge, renamedelete
 
     for d in dirmove:
         repo.ui.debug("  dir %s -> %s\n" % (d, dirmove[d]))
@@ -365,8 +372,8 @@ def mergecopies(repo, c1, c2, ca):
                     # new file added in a directory that was moved, move it
                     df = dirmove[d] + f[len(d):]
                     if df not in copy:
-                        copy[f] = df
-                        repo.ui.debug("  file %s -> %s\n" % (f, copy[f]))
+                        movewithdir[f] = df
+                        repo.ui.debug("  file %s -> %s\n" % (f, df))
                     break
 
-    return copy, diverge, renamedelete
+    return copy, movewithdir, diverge, renamedelete
diff --git a/mercurial/merge.py b/mercurial/merge.py
--- a/mercurial/merge.py
+++ b/mercurial/merge.py
@@ -213,14 +213,15 @@ def manifestmerge(repo, p1, p2, pa, over
         repo.ui.debug(" %s: %s -> %s\n" % (f, msg, m))
         action.append((f, m) + args)
 
-    action, copy = [], {}
+    action, copy, movewithdir = [], {}, {}
 
     if overwrite:
         pa = p1
     elif pa == p2: # backwards
         pa = p1.p1()
     elif pa and repo.ui.configbool("merge", "followcopies", True):
-        copy, diverge, renamedelete = copies.mergecopies(repo, p1, p2, pa)
+        ret = copies.mergecopies(repo, p1, p2, pa)
+        copy, movewithdir, diverge, renamedelete = ret
         for of, fl in diverge.iteritems():
             act("divergent renames", "dr", of, fl)
         for of, fl in renamedelete.iteritems():
@@ -233,6 +234,7 @@ def manifestmerge(repo, p1, p2, pa, over
 
     m1, m2, ma = p1.manifest(), p2.manifest(), pa.manifest()
     copied = set(copy.values())
+    copied.update(movewithdir.values())
 
     if '.hgsubstate' in m1:
         # check whether sub state is modified
@@ -259,14 +261,14 @@ def manifestmerge(repo, p1, p2, pa, over
                 act("versions differ", "m", f, f, f, rflags, False)
         elif f in copied: # files we'll deal with on m2 side
             pass
-        elif f in copy:
+        elif f in movewithdir: # directory rename
+            f2 = movewithdir[f]
+            act("remote renamed directory to " + f2, "d", f, None, f2,
+                m1.flags(f))
+        elif f in copy: # case 2 A,B/B/B or case 4,21 A/B/B
             f2 = copy[f]
-            if f2 not in m2: # directory rename
-                act("remote renamed directory to " + f2, "d",
-                    f, None, f2, m1.flags(f))
-            else: # case 2 A,B/B/B or case 4,21 A/B/B
-                act("local copied/moved to " + f2, "m",
-                    f, f2, f, fmerge(f, f2, f2), False)
+            act("local copied/moved to " + f2, "m", f, f2, f,
+                fmerge(f, f2, f2), False)
         elif f in ma: # clean, a different, no remote
             if n != ma[f]:
                 if repo.ui.promptchoice(
@@ -286,12 +288,13 @@ def manifestmerge(repo, p1, p2, pa, over
             continue
         if f in m1 or f in copied: # files already visited
             continue
-        if f in copy:
+        if f in movewithdir:
+            f2 = movewithdir[f]
+            act("local renamed directory to " + f2, "d", None, f, f2,
+                m2.flags(f))
+        elif f in copy:
             f2 = copy[f]
-            if f2 not in m1: # directory rename
-                act("local renamed directory to " + f2, "d",
-                    None, f, f2, m2.flags(f))
-            elif f2 in m2: # rename case 1, A/A,B/A
+            if f2 in m2: # rename case 1, A/A,B/A
                 act("remote copied to " + f, "m",
                     f2, f, f, fmerge(f2, f, f2), False)
             else: # case 3,20 A/B/A