diff --git a/server/src/agents/lifecycle.rs b/server/src/agents/lifecycle.rs
index dbe4162f..17541240 100644
--- a/server/src/agents/lifecycle.rs
+++ b/server/src/agents/lifecycle.rs
@@ -248,6 +248,28 @@ pub fn transition_to_blocked(story_id: &str, reason: &str) -> Result<(), String>
     .map_err(|e| e.to_string())
 }
 
+/// Transition a story from `Stage::Merge` to `Stage::MergeFailure` via the state machine.
+///
+/// Builds a `PipelineEvent::MergeFailed { reason }`, validates the transition, writes
+/// the resulting `Stage::MergeFailure` to the CRDT, and persists the reason to front
+/// matter so it survives server restarts.
+/// Returns `Err` on `TransitionError` — callers must NOT fall back to direct register writes.
+pub fn transition_to_merge_failure(story_id: &str, reason: &str) -> Result<(), String> {
+    let reason_owned = reason.to_string();
+    let transform: Box<dyn Fn(&str) -> String> = Box::new(move |content: &str| {
+        crate::io::story_metadata::write_merge_failure_in_content(content, &reason_owned)
+    });
+    apply_transition(
+        story_id,
+        PipelineEvent::MergeFailed {
+            reason: reason.to_string(),
+        },
+        Some(&*transform),
+    )
+    .map(|_| ())
+    .map_err(|e| e.to_string())
+}
+
 /// Transition a story out of `Blocked` back to `Coding` via the state machine.
 ///
 /// Builds a `PipelineEvent::Unblock`, validates the transition, writes the
@@ -301,6 +323,7 @@ fn map_stage_move_to_event(
         }),
         (Stage::Coding | Stage::Qa | Stage::Backlog, "done") => Ok(PipelineEvent::Close),
         (Stage::Blocked { .. }, "current") => Ok(PipelineEvent::Unblock),
+        (Stage::MergeFailure { .. }, "backlog") => Ok(PipelineEvent::Unblock),
         (
             Stage::Archived {
                 reason: ArchiveReason::Blocked { .. },
@@ -388,6 +411,7 @@ fn stage_to_name(s: &Stage) -> &'static str {
         Stage::Blocked { .. } => "blocked",
         Stage::Qa => "qa",
         Stage::Merge { .. } => "merge",
+        Stage::MergeFailure { .. } => "merge_failure",
         Stage::Done { .. } => "done",
         Stage::Archived { .. } => "archived",
         Stage::Frozen { .. } => "frozen",
diff --git a/server/src/agents/pool/pipeline/merge/runner.rs b/server/src/agents/pool/pipeline/merge/runner.rs
index d13dfffa..c5d3dd84 100644
--- a/server/src/agents/pool/pipeline/merge/runner.rs
+++ b/server/src/agents/pool/pipeline/merge/runner.rs
@@ -114,16 +114,6 @@ impl AgentPool {
                     Err(e) => e.clone(),
                 };
                 let is_no_commits = reason.contains("no commits to merge");
-                if !is_no_commits {
-                    // Write merge_failure to content for non-blocking failures.
-                    if let Some(contents) = crate::db::read_content(&sid) {
-                        let updated = crate::io::story_metadata::write_merge_failure_in_content(
-                            &contents, &reason,
-                        );
-                        crate::db::write_content(&sid, &updated);
-                        crate::db::write_item_with_content(&sid, "4_merge", &updated);
-                    }
-                }
                 if is_no_commits {
                     if let Err(e) = crate::agents::lifecycle::transition_to_blocked(&sid, &reason) {
                         crate::slog_error!("[merge] Failed to transition '{sid}' to Blocked: {e}");
@@ -135,6 +125,14 @@ impl AgentPool {
                             reason,
                         });
                 } else {
+                    // Transition through the state machine (Merge → MergeFailure).
+                    if let Err(e) =
+                        crate::agents::lifecycle::transition_to_merge_failure(&sid, &reason)
+                    {
+                        crate::slog_error!(
+                            "[merge] Failed to transition '{sid}' to MergeFailure: {e}"
+                        );
+                    }
                     let _ = pool
                         .watcher_tx
                         .send(crate::io::watcher::WatcherEvent::MergeFailure {
diff --git a/server/src/chat/transport/matrix/delete.rs b/server/src/chat/transport/matrix/delete.rs
index a3d316e9..2c2f0390 100644
--- a/server/src/chat/transport/matrix/delete.rs
+++ b/server/src/chat/transport/matrix/delete.rs
@@ -114,6 +114,7 @@ fn stage_display_name(stage: &str) -> &str {
         Some(Stage::Merge { .. }) => "merge",
         Some(Stage::Done { .. }) => "done",
         Some(Stage::Archived { .. }) => "archived",
+        Some(Stage::MergeFailure { .. }) => "merge-failure",
         Some(Stage::Frozen { .. }) => "frozen",
         None => stage,
     }
diff --git a/server/src/http/mcp/merge_tools.rs b/server/src/http/mcp/merge_tools.rs
index d2361c3d..30bd1617 100644
--- a/server/src/http/mcp/merge_tools.rs
+++ b/server/src/http/mcp/merge_tools.rs
@@ -1,7 +1,6 @@
 //! MCP merge tools — merge agent work to master and report merge failures.
 use crate::agents::move_story_to_merge;
 use crate::http::context::AppContext;
-use crate::io::story_metadata::write_merge_failure;
 use crate::slog;
 use crate::slog_warn;
 use serde_json::{Value, json};
@@ -189,30 +188,14 @@ pub(super) fn tool_report_merge_failure(args: &Value, ctx: &AppContext) -> Resul
             reason: reason.to_string(),
         });
 
-    // Persist the failure reason to the story file's front matter so it
-    // survives server restarts and is visible in the web UI.
-    if let Ok(project_root) = ctx.state.get_project_root() {
-        let story_file = project_root
-            .join(".huskies")
-            .join("work")
-            .join("4_merge")
-            .join(format!("{story_id}.md"));
-        if story_file.exists() {
-            if let Err(e) = write_merge_failure(&story_file, reason) {
-                slog_warn!(
-                    "[mergemaster] Failed to persist merge_failure to story file for '{story_id}': {e}"
-                );
-            }
-        } else {
-            slog_warn!(
-                "[mergemaster] Story file not found in 4_merge/ for '{story_id}'; \
-                 merge_failure not persisted to front matter"
-            );
-        }
+    // Route the failure through the typed state machine (Merge → MergeFailure).
+    // This persists the reason in front matter and updates the CRDT stage.
+    if let Err(e) = crate::agents::lifecycle::transition_to_merge_failure(story_id, reason) {
+        slog_warn!("[mergemaster] Failed to transition '{story_id}' to MergeFailure: {e}");
     }
 
     Ok(format!(
-        "Merge failure for '{story_id}' recorded. Story remains in work/4_merge/. Reason: {reason}"
+        "Merge failure for '{story_id}' recorded. Reason: {reason}"
     ))
 }
 
@@ -451,7 +434,6 @@ mod tests {
         assert!(result.is_ok());
         let msg = result.unwrap();
         assert!(msg.contains("42_story_foo"));
-        assert!(msg.contains("work/4_merge/"));
         assert!(msg.contains("Unresolvable merge conflicts"));
     }
 }
diff --git a/server/src/http/mcp/story_tools/epic.rs b/server/src/http/mcp/story_tools/epic.rs
index a2540541..c2b046fc 100644
--- a/server/src/http/mcp/story_tools/epic.rs
+++ b/server/src/http/mcp/story_tools/epic.rs
@@ -144,6 +144,7 @@ pub(crate) fn tool_show_epic(args: &Value, _ctx: &AppContext) -> Result<String,
                 Stage::Merge { .. } => "merge",
                 Stage::Done { .. } => "done",
                 Stage::Archived { .. } => "archived",
+                Stage::MergeFailure { .. } => "merge_failure",
                 Stage::Frozen { .. } => "frozen",
                 Stage::Blocked { .. } => "blocked",
             };
diff --git a/server/src/http/workflow/pipeline.rs b/server/src/http/workflow/pipeline.rs
index 231a6eed..beef38a8 100644
--- a/server/src/http/workflow/pipeline.rs
+++ b/server/src/http/workflow/pipeline.rs
@@ -149,6 +149,7 @@ pub fn load_pipeline_state(ctx: &AppContext) -> Result<PipelineState, String> {
             Stage::Blocked { .. } => state.current.push(story), // blocked shown with current
             Stage::Qa => state.qa.push(story),
             Stage::Merge { .. } => state.merge.push(story),
+            Stage::MergeFailure { .. } => state.merge.push(story), // show merge failures with merge
             Stage::Done { .. } => state.done.push(story),
             Stage::Archived { .. } => {} // skip archived
             Stage::Frozen { .. } => state.backlog.push(story), // show frozen with backlog
diff --git a/server/src/io/story_metadata/fields.rs b/server/src/io/story_metadata/fields.rs
index 25ec8f3b..d055582d 100644
--- a/server/src/io/story_metadata/fields.rs
+++ b/server/src/io/story_metadata/fields.rs
@@ -83,27 +83,6 @@ pub fn clear_front_matter_field(path: &Path, key: &str) -> Result<(), String> {
     Ok(())
 }
 
-/// Write or update a `merge_failure:` field in the YAML front matter of a story file.
-///
-/// The reason is stored as a quoted YAML string so that colons, hashes, and newlines
-/// in the failure message do not break front-matter parsing.
-/// If no front matter is present, this is a no-op (returns Ok).
-pub fn write_merge_failure(path: &Path, reason: &str) -> Result<(), String> {
-    let contents =
-        fs::read_to_string(path).map_err(|e| format!("Failed to read story file: {e}"))?;
-
-    // Produce a YAML-safe inline quoted string: collapse newlines, escape inner quotes.
-    let escaped = reason
-        .replace('"', "\\\"")
-        .replace('\n', " ")
-        .replace('\r', "");
-    let yaml_value = format!("\"{escaped}\"");
-
-    let updated = set_front_matter_field(&contents, "merge_failure", &yaml_value);
-    fs::write(path, &updated).map_err(|e| format!("Failed to write story file: {e}"))?;
-    Ok(())
-}
-
 /// Write `review_hold: true` to the YAML front matter of a story file.
 ///
 /// Used to mark spikes that have passed QA and are waiting for human review.
diff --git a/server/src/io/story_metadata/mod.rs b/server/src/io/story_metadata/mod.rs
index eadef1ff..913a21d9 100644
--- a/server/src/io/story_metadata/mod.rs
+++ b/server/src/io/story_metadata/mod.rs
@@ -14,9 +14,9 @@ mod types;
 pub use deps::{check_archived_deps, check_archived_deps_from_list, check_unmet_deps};
 pub use fields::{
     clear_front_matter_field, clear_front_matter_field_in_content, set_front_matter_field,
-    write_depends_on, write_depends_on_in_content, write_merge_failure,
-    write_merge_failure_in_content, write_mergemaster_attempted_in_content,
-    write_rejection_notes_to_content, write_review_hold, write_review_hold_in_content,
+    write_depends_on, write_depends_on_in_content, write_merge_failure_in_content,
+    write_mergemaster_attempted_in_content, write_rejection_notes_to_content, write_review_hold,
+    write_review_hold_in_content,
 };
 pub use parser::{
     is_story_frozen_in_store, parse_front_matter, parse_unchecked_todos, resolve_qa_mode,
diff --git a/server/src/io/watcher/mod.rs b/server/src/io/watcher/mod.rs
index ace0e16d..c4da8209 100644
--- a/server/src/io/watcher/mod.rs
+++ b/server/src/io/watcher/mod.rs
@@ -55,6 +55,9 @@ pub fn stage_metadata(stage: &str, item_id: &str) -> Option<(&'static str, Strin
         Stage::Blocked { .. } => ("block", format!("huskies: block {item_id}")),
         Stage::Qa => ("qa", format!("huskies: queue {item_id} for QA")),
         Stage::Merge { .. } => ("merge", format!("huskies: queue {item_id} for merge")),
+        Stage::MergeFailure { .. } => {
+            ("merge_failure", format!("huskies: merge_failure {item_id}"))
+        }
         Stage::Done { .. } => ("done", format!("huskies: done {item_id}")),
         Stage::Archived { .. } => ("accept", format!("huskies: accept {item_id}")),
         Stage::Frozen { .. } => ("freeze", format!("huskies: freeze {item_id}")),
diff --git a/server/src/pipeline_state/projection.rs b/server/src/pipeline_state/projection.rs
index 8ed5dfcf..1f629dac 100644
--- a/server/src/pipeline_state/projection.rs
+++ b/server/src/pipeline_state/projection.rs
@@ -91,6 +91,14 @@ pub fn project_stage(view: &PipelineItemView) -> Result<Stage, ProjectionError>
                 commits_ahead: NonZeroU32::new(1).expect("1 is non-zero"),
             })
         }
+        "4_merge_failure" => {
+            // The reason is persisted in front-matter (merge_failure: "...") but
+            // is not part of the raw CRDT view; the projection uses an empty
+            // string here.  Consumers that need the reason should read content.
+            Ok(Stage::MergeFailure {
+                reason: String::new(),
+            })
+        }
         "5_done" => {
             // Use the stored merged_at timestamp if present.  Legacy items
             // that pre-date this field have merged_at = None, so we fall back
diff --git a/server/src/pipeline_state/tests.rs b/server/src/pipeline_state/tests.rs
index 3e4a4fd9..44b53170 100644
--- a/server/src/pipeline_state/tests.rs
+++ b/server/src/pipeline_state/tests.rs
@@ -655,4 +655,57 @@ fn regression_freeze_unfreeze_restores_crdt_stage() {
     );
 }
 
+// ── Story 868: MergeFailure regression ─────────────────────────────
+
+/// Regression test (story 868): applying `PipelineEvent::MergeFailed` to a story
+/// in `Stage::Merge` transitions it to `Stage::MergeFailure` and the emitted
+/// `TransitionFired` event carries the full reason string in its payload.
+#[test]
+fn merge_failure_transition_emits_event_with_full_reason() {
+    crate::crdt_state::init_for_test();
+    crate::db::ensure_content_store();
+
+    let story_id = "99868_story_merge_failure_event";
+    crate::db::write_item_with_content(
+        story_id,
+        "4_merge",
+        "---\nname: Merge Failure Event Test\n---\n# Story\n",
+    );
+
+    let reason = "Conflict in server/src/main.rs: both modified";
+    let fired = super::apply::apply_transition(
+        story_id,
+        PipelineEvent::MergeFailed {
+            reason: reason.to_string(),
+        },
+        None,
+    )
+    .expect("MergeFailed transition should succeed");
+
+    // The emitted event payload carries the full reason string.
+    match &fired.event {
+        PipelineEvent::MergeFailed { reason: r } => {
+            assert_eq!(r, reason, "emitted event should carry the full reason");
+        }
+        other => panic!("expected MergeFailed event, got: {other:?}"),
+    }
+
+    // The story transitioned to MergeFailure.
+    assert!(
+        matches!(fired.after, Stage::MergeFailure { .. }),
+        "after-stage should be MergeFailure: {:?}",
+        fired.after
+    );
+
+    // Verify CRDT reflects the new stage.
+    let item = read_typed(story_id)
+        .expect("CRDT read should succeed")
+        .expect("item should exist");
+    assert_eq!(
+        item.stage.dir_name(),
+        "4_merge_failure",
+        "CRDT stage should be 4_merge_failure"
+    );
+}
+
 // ── ProjectionError Display ─────────────────────────────────────────
diff --git a/server/src/pipeline_state/transition.rs b/server/src/pipeline_state/transition.rs
index f9be223b..37510e4b 100644
--- a/server/src/pipeline_state/transition.rs
+++ b/server/src/pipeline_state/transition.rs
@@ -33,6 +33,9 @@ pub enum PipelineEvent {
     },
     /// Mergemaster squash succeeded.
     MergeSucceeded { merge_commit: GitSha },
+    /// Merge pipeline failed (conflicts or gate failures); story moves to
+    /// `Stage::MergeFailure` awaiting human intervention or retry.
+    MergeFailed { reason: String },
     /// Mergemaster gave up after retry budget.
     MergeFailedFinal { reason: String },
     /// Story accepted (Done → Archived).
@@ -87,6 +90,7 @@ pub fn event_label(e: &PipelineEvent) -> &'static str {
         PipelineEvent::GatesFailed { .. } => "GatesFailed",
         PipelineEvent::QaSkipped { .. } => "QaSkipped",
         PipelineEvent::MergeSucceeded { .. } => "MergeSucceeded",
+        PipelineEvent::MergeFailed { .. } => "MergeFailed",
         PipelineEvent::MergeFailedFinal { .. } => "MergeFailedFinal",
         PipelineEvent::Accepted => "Accepted",
         PipelineEvent::Block { .. } => "Block",
@@ -174,6 +178,9 @@ pub fn transition(state: Stage, event: PipelineEvent) -> Result<Stage, Transitio
             reason: ArchiveReason::ReviewHeld { reason },
         }),
 
+        // ── MergeFailed: Merge → MergeFailure (recoverable intermediate) ──
+        (Merge { .. }, MergeFailed { reason }) => Ok(MergeFailure { reason }),
+
         (Merge { .. }, MergeFailedFinal { reason }) => Ok(Archived {
             archived_at: now,
             reason: ArchiveReason::MergeFailed { reason },
@@ -221,6 +228,9 @@ pub fn transition(state: Stage, event: PipelineEvent) -> Result<Stage, Transitio
         // ── Unblock: Blocked → Coding ─────────────────────────────────
         (Blocked { .. }, Unblock) => Ok(Coding),
 
+        // ── Unblock MergeFailure → Backlog ───────────────────────────────
+        (MergeFailure { .. }, Unblock) => Ok(Backlog),
+
         // ── Legacy unblock: Archived(Blocked|MergeFailed) → Backlog ──
         (
             Archived {
diff --git a/server/src/pipeline_state/types.rs b/server/src/pipeline_state/types.rs
index 195118f1..c93c04c2 100644
--- a/server/src/pipeline_state/types.rs
+++ b/server/src/pipeline_state/types.rs
@@ -60,9 +60,9 @@ impl fmt::Display for AgentName {
 /// | current         | `Coding`                          |
 /// | qa_pending      | `Qa`                              |
 /// | merge_pending   | `Merge { .. }`                    |
+/// | merge_failure   | `MergeFailure { .. }`             |
 /// | done            | `Done { .. }`                     |
 /// | blocked         | `Blocked { .. }`                   |
-/// | merge_failure   | `Archived { MergeFailed { .. } }` |
 /// | archived        | `Archived { Completed }`          |
 /// | superseded      | `Archived { Superseded { .. } }`  |
 /// | rejected        | `Archived { Rejected { .. } }`    |
@@ -106,6 +106,11 @@ pub enum Stage {
         reason: ArchiveReason,
     },
 
+    /// Merge pipeline failed (conflicts or gate failures). Story is held here
+    /// awaiting human intervention or retry.  Unlike `Archived(MergeFailed)`,
+    /// this is a recoverable intermediate state — `Unblock` returns to `Backlog`.
+    MergeFailure { reason: String },
+
     /// Pipeline advancement and auto-assign are suspended. Resumes to
     /// `resume_to` when unfrozen.
     Frozen { resume_to: Box<Stage> },
@@ -154,12 +159,13 @@ impl Stage {
         stage_dir_name(self)
     }
 
-    /// Returns true if this is the `Blocked` variant (or the legacy
-    /// `Archived(Blocked)` for backward-compatible reads).
+    /// Returns true if this is the `Blocked` or `MergeFailure` variant (or the
+    /// legacy `Archived(Blocked)` for backward-compatible reads).
     pub fn is_blocked(&self) -> bool {
         matches!(
             self,
             Stage::Blocked { .. }
+                | Stage::MergeFailure { .. }
                 | Stage::Archived {
                     reason: ArchiveReason::Blocked { .. },
                     ..
@@ -198,6 +204,11 @@ impl Stage {
             }),
             // Frozen: stub with Coding as resume_to — rich resume_to is loaded
             // from front matter by the projection layer.
+            "4_merge_failure" => Some(Stage::MergeFailure {
+                reason: String::new(),
+            }),
+            // Frozen: stub with Coding as resume_to — rich resume_to is loaded
+            // from front matter by the projection layer.
             "7_frozen" => Some(Stage::Frozen {
                 resume_to: Box::new(Stage::Coding),
             }),
@@ -278,6 +289,7 @@ pub fn stage_label(s: &Stage) -> &'static str {
         Stage::Coding => "Coding",
         Stage::Qa => "Qa",
         Stage::Merge { .. } => "Merge",
+        Stage::MergeFailure { .. } => "MergeFailure",
         Stage::Done { .. } => "Done",
         Stage::Blocked { .. } => "Blocked",
         Stage::Archived { .. } => "Archived",
@@ -294,6 +306,7 @@ pub fn stage_dir_name(s: &Stage) -> &'static str {
         Stage::Blocked { .. } => "2_blocked",
         Stage::Qa => "3_qa",
         Stage::Merge { .. } => "4_merge",
+        Stage::MergeFailure { .. } => "4_merge_failure",
         Stage::Done { .. } => "5_done",
         Stage::Archived { .. } => "6_archived",
         Stage::Frozen { .. } => "7_frozen",
diff --git a/server/src/service/agents/mod.rs b/server/src/service/agents/mod.rs
index 0ba0af32..3a97be69 100644
--- a/server/src/service/agents/mod.rs
+++ b/server/src/service/agents/mod.rs
@@ -208,6 +208,7 @@ pub fn get_work_item_content(
                 crate::pipeline_state::Stage::Blocked { .. } => "blocked",
                 crate::pipeline_state::Stage::Qa => "qa",
                 crate::pipeline_state::Stage::Merge { .. } => "merge",
+                crate::pipeline_state::Stage::MergeFailure { .. } => "merge_failure",
                 crate::pipeline_state::Stage::Done { .. } => "done",
                 crate::pipeline_state::Stage::Archived { .. } => "archived",
                 crate::pipeline_state::Stage::Frozen { .. } => "frozen",
diff --git a/server/src/service/notifications/format.rs b/server/src/service/notifications/format.rs
index 73a8b0f6..9b7a6494 100644
--- a/server/src/service/notifications/format.rs
+++ b/server/src/service/notifications/format.rs
@@ -18,6 +18,7 @@ pub fn stage_display_name(stage: &str) -> &'static str {
         Some(Stage::Merge { .. }) => "Merge",
         Some(Stage::Done { .. }) => "Done",
         Some(Stage::Archived { .. }) => "Archived",
+        Some(Stage::MergeFailure { .. }) => "MergeFailure",
         Some(Stage::Frozen { .. }) => "Frozen",
         None => "Unknown",
     }