I read this whole thing, and I'm inclined to agree with Hong, at least partially. You have no idea how much that saddens me.
Looking at this the way it'd be in my game, uh, yeah, it's evil. When the king's man says that he intends to do something (all that was said, according to the poster, was, "I'm taking the child."), and refuses to answer your questions (which he doesn't actually have to answer, since he is the authority figure, and you aren't), legitimate options include agreeing, using your own political influence to deal with the situation, or refusing and asking for a neutral political rep to deal with this situation through legal channels, or even just running away to get to a political person with as much weight as the person you're running from. You don't generally, uh, kill that person and then desecrate the body. Anyone who finds killing someone based on the evidence provided by the original poster to be an acceptable solution would not enjoy my game... and may have some issues to work through.
Looking at this from a game-design perspective, though, I find the problem interesting. A lot of people are insisting that the players should get to do whatever they like, and it isn't fun to have consequences like other people want. I disagree with their opinion, but ultimately, I think they're on the track of the right question, which is, "In this campaign, where does the fun come from?"
In some campaigns, the fun comes from unlocking a deep story. The price you pay for that fun is some railroading, or, if not railroading, a dearth of other things to do -- you can spend all day talking to the merchant, yeah, but the only real thing of interest is the cave where all the local kids have been disappearing.
In some campaigns, the fun comes from wandering around and doing whatever comes into your head. The price you pay for that fun is the lack, usually, of a really deep story, since you're essentially sandboxing, and any story that you come up with is limited by what the DM can come up with on the spur of the moment.
In some campaigns, the fun comes from getting more powerful and making a bigger boom as you kill monsters. The price you pay for that fun can come in the form of a story limitation (you just get pointed at big nasties) or an exploration limitation (you just get pointed at one dungeon, so the DM knows where you'll be next session).
In the original post, the issue I see is that the DM wants a cause-and-effect world where actions have consequences, and the players clearly don't want that. They want to kill things and take their stuff. Both types of games can be a lot of fun, but cause-and-effect usually works better in a world with a tighter story, where players are motivated to stay in character to see what happens. Killing things and taking their stuff only works with a story if the DM is willing to come down hard and impose limitations -- ideally, without making the player look like a chump in the process.
To OP: I would avoid the second arbiter like the plague. That's dealing with it in-game. I'd go with what others have suggested. Keep it out of game, and ask people what they want. Tell them what kind of game you'd like to run, and what kind of game you're willing to run. If you and the players can't find a good middle ground, then play something else, or have someone else run the game. Everyone needs to have fun in a game, or something is being done wrong. I wouldn't want to see my careful story-centric game upended by somebody who wants to kill anyone who is rude to him, and I wouldn't want to hurt someone's feelings by running a pure "kill anything, no rules" game and having bad things happen offstage (as setup for the next big fight) without the heroes getting the chance to stop it.
