1) No pic shows up
2) Are you SURE you have the spacers in the right way ? 1 way will move the c-clips closer to the center pin than the other does (and give you the same problem you describe)
If the pinion moves that much before engaging, something ain't right.......if the pattern truly is good, then you may have worn axle shaft splines, or something isn't right with the locker and gears.
I am assuming this the a full case locker.
Someone used a pipe wrench to loosen and/or tighten the yoke, and then a belt sander or file to try and hide the damage.....
With that said, I'd suspect all of the work they did at this point.....
Get some filters or a respirator to wear under that welding hood.........the fumes will make you sick at best, kill you at worst....
My plasma cutter was 600 on ebay.....been working great for 15 yrs.....
Well, those 'pretty' flares aren't plastic...they are fiberglass.
I also would not 'cut above the holes' when you take them off.....that will leave you no metal if you change your mind later. They are high enough they will put you past the point of recovery later on.
Why not use a rivet or...
Well, at 3.5" I wouldn't even use those plates.......
I'm @ 3.75"- 4" of lift on mine, running 32" tires on 17" moabs....and I do have an extended bumpstop up top, but still no plate, just the stock configuration.....
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Usually, you have to look for the instructions on the site and you can see from there.
Some ideas on how to strengthen things up:
http://uphillmfg.com/product/jeep-xj-cherokee-rear-tie-in-brackets/
https://www.t-mfab.com/store-3/jeep-cherokee-xj-behind-the-rear-bumper-stiffiner/
Best thing for most is a hitch or good bumper......and if you want to do more, then you can do the frame inserts and they even sell stiffeners for the rear frame as well.
I plan on doing inserts and a good bumper & hitch on mine......