In this situation, where C1 is an archer, C2 is a dragon, and the black squares are walls, C2 has cover from C1? What? That's just plain hosed up.
The relevant quote is on DDM2's rulebook, page 30:
Ranged Cover
To determine ranged cover, the attacker chooses a corner of its square. If any line from this point to any part of the defender's space is blocked by a wall (or other blocking terrain), the defender has cover. When attacking Large or larger creatures, those lines must be drawn to all squares the target occupies.