#!/bin/sh

p1="$1"
shift
p2="$1"
shift

for file in *
do
      echo $p1
      echo $p2

      sed "s/$p1/$p2/g" $file >temp.out
      mv temp.out $file
done

sub3 appears to be treating its first parameter as the name of a file to be edited.

#!/bin/sh

p1="$1"
shift
p2="$1"
shift
p3="$1"
shift


for file in *
do
      echo $p1
      echo $p2
      echo $p3

      sed "s/$p1/$p2/g" "$p3" > temp.out
      mv temp.out "$p3"
done

for file in *
do
  echo Looking at $file.
  count=`expr $count + 1`
  echo Count is $count.
done

sub3 produced incorrect output on test 29: /directory/sub3 'e' 'x' '_bongo.dat' '_cat.dat'