Oh, I might have misunderstood your question. In the case of the velocity iteration we still have the following:

dC/dt = ( v2 + w2 x r - v1 - w1 x r1 ) * n + **( x2 + r2 - x1 - r1 ) * dn/dt**

But now either **x2 + r2 - x1 - r1 = 0 **if you setup the local contact points from global ones. Or in the case where the local points are disjoint (I think you asked about this earlier) you compute the normal from the difference vector anyway in which case the cross product **( x2 + r2 - x1 - r1 ) x n **would vanish since the vectors are parallel.

This might not matter in practice at all. You have a similar problem with prismatic joints. If you ignore the right term you get problems if the bodies are sliding apart quite a bit. Penetrations are usually small so it might not matter. Formally this would be the correct way though.