After the training concludes, Lazlo and his fellow knight trainees head home to Razril, where they are to be pronounced full-fledged Gaien knights.
After the ceremonial Kindling Ritual and a night of feasting, Lazlo awakens the next morning for his first duties as a new knight, including the task of escorting a man named Ramada to the neighboring island of Iluya. During the trip there, they are attacked by Brandeau and his pirates. Snowe abandons the ship after being fired upon by "rune cannons," while Lazlo decides to brave the attacks and stay, thus inspiring jealousy in his cowardly comrade. Brandeau then boards Lazlo's ship and challenges him to a duel, which the young knight unexpectedly wins. As a last effort, Brandeau unleashes the power of the Rune of Punishment and attempts to destroy everyone, but a mysterious force shields Lazlo from its might. Glen arrives to save his men, and in that brief moment, the Rune of Punishment is passed from Brandeau to Glen, after which Brandeau evaporates into dust.
Soon after, the knights retreat back to Razril. Several enemy fleets attack in succession, finally forcing Glen to repel them with the power of the deadly Rune. In the aftermath, Lazlo finds the Commander dying, and unwittingly becomes the Rune of Punishment's next bearer. Snowe arrives just in time to witness Glen's evaporation and blames Lazlo for killing him. Katarina, who assumes command in Glen's stead, believes Snowe's story and sentences Lazlo to exile from the island. Drifting aimlessly on a small boat, Lazlo discovers that two of his fellow knights, as well as a wandering merchant, have stowed away to join him.
As Lazlo and his companions drift on the open sea, they come across one of the militaristic Kooluk nation's merchant ships, which takes them on board. However, Lazlo discovers that the ship is actually a military vessel, captained by the Kooluk hero Troy, and that Lazlo's former charge Ramada had been a Kooluk spy. Troy catches Lazlo eavesdropping, draws steel and easily defeats him in a fight, but then allows the banished knight and his friends to flee. Adrift again, the companions wash up on a deserted island, where they forage for materials and eventually build a raft to leave. This time, they encounter a ship from the friendly kingdom of Obel, and are welcomed as guests.
The ship's crew inspects Lazlo, recognizes the Rune on his hand, and sends him to meet with Lino En Kuldes, Obel's young and capable king. Lino En Kuldes hires Lazlo, putting him in charge of recruiting new talent to help shore up Obel's defenses in the event of a Kooluk invasion. Lazlo's first assignment is to meet and recruit the inventor Oleg. During their meeting, Oleg's invention (the world's first movie camera) captures Kooluk's Rune Cannon strike on Illuya. This prompts the King of Obel to take serious action, but too late; Obel is next on Kooluk's list, and Lazlo, his friends, and Lino En Kuldes himself are all forced to flee in Obel's secret flagship (which becomes the hero's HQ for the remainder of the game). The Kooluk forces, with the backing of the arms merchant Graham Cray, conquer Obel with ease, establishing a foothold for their planned southern expansion.
In need of help, Lazlo and company join forces with the pirate queen Kika, who suggests the recruitment of the tactician Lady Elenor Silverberg. Elenor is reluctant to help, but joins once she hears that Graham Cray is involved. She quickly forms a plan to liberate each of the Island Nations, then bring them together to face the Kooluk as a united front.