Hi Phani,
You need to check the rights of U2 and U3 related read' and 'write' permission for contact and account set the Business Unit B2 and B3 respectively. Check if any teams access are assigned to U3 or no.
What all fields did you merge from the C2 to C1 ?
Could you also confirm if C2 is visible to U2 under B2 in inactive contacts ?
I was replicated the case and C2 was not visible to U3 under B3 and was visible in Inactive Contacts to U1 and U2 under B1 and B2 respectively.