
Cfoot |

This +1 greatsword is decorated with a lock motif. On a successful hit with the sword against a creature that is the wielder's size or smaller, the wielder can attempt to start a grapple as a free action that doesn't provoke an attack of opportunity. If the wielder succeeds at the grapple, the sword's blade transforms into a metal chain and wraps around the target, giving the wielder a +5 bonus on further grapple checks against the target. If the target escapes the grapple or the wielder decides to release the target from the grapple, the chain reverts to sword form (with the wielder holding the handle).
The wielder can also let go of the chain's handle while grappling or pinning the target; if he does so, the chain remains in place and the target gains the entangled condition (Escape Artist DC 20 to slip free, break DC 28, hardness 10, 10 hit points, concentration DC 17 to cast spells while entangled). Another creature can grab the chain's handle as a standard action and will it to revert to sword form as a swift action, which releases the bound creature. If the chain is destroyed, it reverts to sword form and the weapon gains the broken condition.
So you attack with the sword and get a free grapple attempt. You are successful on the grapple.
1) Next turn you roll to maintain the grapple. Do you take a -4 penalty for not having two hands free because you are holding the chain/sword or are you considered to be using the chain/sword to perform the grapple so there is no penalty (as opposed to if you were holding a long sword that was not being used in the act of grappling)?
2) You maintain the grapple and wish to deal damage. Are you using the chain/sword or unarmed strike to damage?

Emo Duck |

1) I imagine the intent is that you do not take the -4 penalty. The hand holding the handle is directly contributing to holding onto the target, so that'd be my interpretation. I also imagine the +5 bonus stacks with the bonus you get from simply controlling the grapple.
2) I think you do unarmed damage (unless you're holding another weapon in your other hand - in which case the -4 penalty from question #1 would apply), as the sword doesn't function as a sword at this point.