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The film opens with graphic scenes of bombings of a US building where many US forces are casualties. The blame is placed on the group led by Sheik Ahmed Bin Talal and he is apprehended and taken into the custody during a surgical extraction raid.

FBI Special Agent Anthony Hubbard (Denzel Washington) and his Arab partner Frank Haddad (Tony Shalhoub), arrive at the scene of a terrorist crisis in New York City, where hostages are being held aboard a bus containing a bomb. The bomb turns out to be merely a huge paint-bomb, and unbeknown to the FBI and police the terrorists fled before anyone had arrived at the scene. The FBI team receives a phone call stating that there will be real bombs and a mysterious message stating "release him".

The next bomb is also aboard a bus. Hubbard gets the terrorists to release all the children on the bus, but despite further attempts to negotiate, the bomb explodes, killing everyone still aboard. A CIA agent, Elise Kraft, involved with her own agency's investigation of the bombing, shows up but cannot give Hubbard any details. Samir admits to signing the visa application of one of the suicide bombers as he admits to signing many applications for student visas in his job as a lecturer. However, Kraft insists that Samir is not a terrorist, and that his continued freedom is vital to the investigation.

Nonetheless, the FBI locates the first cell and takes them out in a shootout, unaware of a second sleeper cell which then becomes activated and bombs a theater. A third cell bombs the offices of the FBI Counterterrorism Division at One Federal Plaza.

The Federal Government seeks options. Major General William Devereaux (Willis) insists that the Army is not the right "tool" for this job, being a "broadsword not a scalpel." Hubbard recommends continued use of the FBI to seek out and neutralize the suspects. During this meeting , Kraft's true name is revealed to be Sharon Bridger. Nonetheless, the President declares martial law, and the Army, under Major General Devereaux, occupies and seals off Brooklyn in an effort to find the remaining terrorist cells. Subsequently, all young males of Arab descent, including Haddad's son, are rounded up and detained in a makeshift prison camp in Yankee Stadium. Haddad quits the FBI. New Yorkers stage violent demonstrations against the army and the singling out of the Arabs, and the Army fights to maintain control. There are reports of Army killings.

Hubbard and Kraft continue their investigation and capture a suspect, Tariq Husseini. Devereaux takes custody of him and tortures and kills him in an interrogation, against the objections of Hubbard. After this Bridger tells Hubbard that Husseini knew nothing and, sickened, finally tells Hubbard what she knows. It turns out that she trained anti-Saddam Iraqis to make bombs and these men were let into the country by her when, after their funding was cut, the group and their people from Northern Iraq were massacred under the Hussein regime. She and Hubbard compel Samir to arrange a meeting with the final terrorist cell. Hubbard convinces Haddad he needs his help and he returns to the FBI.

A peaceful march involving all ethnic groups in New York demonstrates against the occupation of Brooklyn. As the march is getting under way Bridger and Samir arrive at the meeting place, but Bridger and Samir have already left. Samir reveals to Bridger that he himself is the final cell. He straps a bomb to his body which he intends to detonate amongst the marchers. Hubbard and Haddad arrive in time to stop him leaving, but Samir fatally shoots Bridger as she struggles to stop him, and Hubbard kills Samir.

Hubbard, accompanied by other FBI agents, places Devereaux under arrest for the torture and murder of Tariq Husseini. Devereaux declares himself to be the law, and commands his soldiers to aim their guns at the FBI agents resulting in a Mexican standoff. Hubbard reminds Devereaux that the civil liberties and human rights which he took from Husseini are what all his predecessors have fought and died for. Devereaux finally submits to arrest. Martial law ends, and the detainees are freed, including Haddad's son.

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