Updating to Java 1.6 solved my problem. Thanks for the quick advice!
I am using xi:include to pull in other xml files which in turn include other xml files until I done this 5 levels deep. But after the the 3rd level of nesting I get an error. Unfortunately either Saxon or Xerces fails giving the following error:
SXXP0003: Error reported by XML parser: The prefix "xi" for element "xi:include" is not bound.
I am using Saxon 220.127.116.11 running on Sun Java 1.5.0_11