Why not group people into free-form clusters based on user density? So, if you have 5 people that are effectively in the same building, and 3 people that are outside of it in various directions, group those 3 into the 5. This has the effect of forming virtual chat rooms that come and go.

Not sure what you're using on the backend, but if it's PostGIS... here you go: http://gis.stackexchange.com/questions/11567/spatial-cluster...

How about a 1 mile (square) zone, rather than 1 mile away from you? So you just cut everything up into mile-square slices, and you can talk with everyone in your slice... Concept is basically the same, but should overcome that issue.

Make A see only see C's reponses to B.