When engaged with an opponent, you take up roughly 5 sq ft of space on the board. This is to represent the back and forth and moving to or fro of combat.
Even when you have a pole-arm and a sword fighter has closed in on you, you don't fight with penalties because you have space to move around, however that is not always the case. It's only when you get backed into a wall that things start to become a problem.
For example: these two fighters are battling out in the alley behind the tavern because the sword fighter (blue) insulted the pole-arm fighter's (red) girlfriend. Blue is using a long sword (3 1/2 foot reach) while Red is Halberd (7 foot reach).
While there is a lot of debris in the alley, they still both have enough space to maneuver their weapons so even though Blue's token is touching Red's, Red fighter without a penalty as he's choked up on his weapon and has enough enough space behind him to work with.
However, if you are pushed up against a wall or another person fighting or really anything that keeps you from having the space you need to fight, problems start to arise for the bigger weapons. If your character is against some behind them then they get a penalty to their attack, defense, speed, and damage equal to how many feet over 5 ft their weapon is.
Continued example: Red and Blue continue to exchange blows. Realizing that the cramped conditions could give him an advantage, Blue bull-rushes Red, succeeding in diving him back against the wall.
Now that his back is blocked, Red is less able to move his Halberd about to attack or defend and takes a penalty of 2 to his Attack, Defense, Speed, and Damage because his base reach is 7.
Being pushing into a corner is bad for everybody, not just weapons with longer reach. When up against a wall, the situation can turn dire even for the smallest weapon.
Should your opponent score a knock-back on you while your back is against a wall, then you automatically take 2(d4p-2) +1 for every point of damage over what was needed to knock you back originally -1 for every foot traveled to get there, as your character is slammed against the wall. You can make a Feat of Agility to half that damage by half the amount of damage you initially took is added to the opposed roll, so the harder you were knocked back, the less likely you are to avoid the damage.
As you recover, your attacker can then press forward, further pushing you against the wall. He halves whatever remaining fighting space you have (rounded up). So, the first time he limits your fighting space to 3 feet, then to 2, then to 1.
Not that this is without cost for him, as it limits his fighting space by the same amount as well as he has to get in close and personal to force his advantage.
Continued Example: Red knows that he's in trouble unless he turns the tables soon so he begins to Attack Aggressively. Blue, knowing how badly a Halberd can if it strikes true, decides to give him the ground and begins to shuffle back.
Spurned on by the move, Red closes the gap and swings, scoring a double knock back and sending him against the alley. He drops his dagger and charges Blue.
The charge is successful. Red is a pretty swole dude and even with the dagger, he does 9 damage, which because he charged, counts at 18 damage for the purposes of knock backs, throwing Blue into the wall behind him.
Blue then makes a FoA vs d20p+9 because even though the dagger technically only did 9 damage, it was still counted as 18 for the purposes of knocking him back.
Blue makes it and takes half of 2(d4p-2)+3. Still, he was thrown back into the wall and Red moves up with his dagger.
Now both fighters are fighting in a smaller space. Blue is finding it a tad bit difficult to maneuver his long sword in the cramped conditions, but he's doing alright for himself only taking a penalty of 1 to his Attack, Defense, Speed, and Damage, while Red is having no trouble in the these conditions to wield his dagger.
The battle continues with neither side gaining or losing ground until Red, spurred on by his fury at Blue's insult, does a particularly powerful blow with his dagger, knocking Blue back further and limiting him to 2 feet of fighting space.
Because the Longsword's reach is 3 1/2 feet it gets a penalty of 2 to Attack, Defense, Speed, and Damage, really putting a damper on Blue's ability to pull out a win.
If the tables had been turned and Red was still fighting with his Halberd in 2 feet of space then he'd be fighting at a penalty of 5 to Attack, Defense, Speed, and Damage but since he's using a dagger he's breathing easy.
Red delivers the final blow, gutting Blue and letting his body slide down the wall. He wipes his blade on Blue's tunic, retrieves his Halberd and disappears into the night mist. To be fair to Blue, Red's girlfriend is pretty ugly.
