Now I found this:
http://msdn.microsoft.com/archive/en-us/ddraw7/directdraw7/ddover_7ctz.asp
I read from there that source rect must be inside src. Destination _may_ be outside, only if something called 'clipper' is attached to dst.
OK, so according to my testings plus your MSDN findings, I attached a patch that should match 'feature to feature' what the real DirectX does... It certainly won't help you with your Grim problem though (BTW I tested it with an application that set a clipper and it still works fine).
Well, on my Grim Fandango testings it started when Calavera tried to walk to Big Boss cabinet (after talking Celso) - so near the end.
Do you have a save game for that so that I try it on my version of Grim (I may even test it on my Windows box :-) ).
Lionel