Antonio explains that his offence in Illyria, which was theft, was one the rest of his city have repaid but he has not and so he is still wanted in Illyria. Sebastian decides to look around, but Antonio fearful of his enemies, decides to head for lodging at a place called "the Elephant." Antonio gives Sebastian his purse (wallet) and directions to this lodging and the two part their separate ways...
Olivia makes plans to once more woo Cesario (Viola). Olivia sees Malvolio with yellow stockings and cross-gartered and considers him mad since he continues to smile no matter what the situation and makes crude, lustful interpretations of Olivia's words.
Malvolio makes his famous "'Some are born great,'-" speech.
Learning that Cesario has returned, Lady Olivia has Malvolio put into the care of her servants since in her eyes, Malvolio's behavior is some "midsummer madness."
Sir Toby, Maria and Fabian plot to have Malvolio placed in a "dark room," so they can have some fun with him. Sir Andrew arrives with his completed letter challenging Cesario. Sir Toby decides to verbally scare Cesario and Sir Andrew about their opponents instead of sending the letter.
Alone with Cesario once more, Lady Olivia makes no progress with Cesario who will not requit (return) her love. Olivia is undaunted by this. Sir Toby scares both Sir Andrew and Cesario into drawing their weapons on each other.
Antonio arrives, pledging to fight Sir Andrew on Cesario's (Viola's) behalf who he thinks is Sebastian since Viola disguised as a man now looks like her twin brother Sebastian.
The fight is stopped but Officers recognizing Antonio, capture him. Antonio asks Cesario (Viola) for his purse back but Cesario not recognizing him does not oblige.
Antonio thinks Sebastian has betrayed him, not realizing he has asked Cesario (Viola) for his purse, not Sebastian.