My wife and I discovered an easy, if not painless, way to save the Dwarf.
The hint is when the Spirit of the Priest says that he "Knows that the Demon can be killed by torturing the Dwarf long enough. The Dwarf could take it, but the Priest could not."
The Dwarf says the same in that he can take it but that the DEMON cannot. The Demon keeps telling you to stop if you hit the Dwarf. The Demon also "hates his bloody prison" after you wound the Dwarf enough.
It's like a riddle... and the solution is:
To beat on the Dwarf and bring him to 1 health using the spell "Living on the Edge", then healing him back to full health. Repeat this 6 times. After 6 rounds of doing this, you will notice your characters gain experience, signifying that the demon has died. Kill the final tower, free the Dwarf, and the Demon pops out of him [i]completely dead[/i]!
Hope this helps :birthdayjump: