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this quest is bugged for me, first time i did this my main character got posessed and died so i wanted to load from a previous save where i hit the dwarf a couple of times so i could prepare, after hitting the demon once everyone but the character hit him became enemies and game crashes any time i load a previous save at that point, loading back to the entrance is fine
it's weird, I saved the dwarf and killed the demon when I did the final blow against my possessed character (I think demon was at like 5 health), but then it disappeared and there's no demon body in sight. Also, the dwarf keeps saying he owes the one who set him free everything, but the dialogue doesnt change when I cycle through all of my pcs. Maybe because I found his treasure earlier with 18 wits? Either way, the quest just closed for me without any rewards other than xp. :/
Even if it's a killing blow, the demon will still possess someone, rendering its corpse unlootable because it won't be exist after the final possession. You need to let the dwarf kill it without any of your team members nearby to avoid the possession.
Scoundrel Rogue used Peace of mind before breaking the last pillar. Went first and used chameleon cloak, cloak and dagger to backstabbing position and then mortal blow to one shot demon... home for lunch.
Knockdown Arrows. Yw.
Why not just make it a unique skill/buff to possess a character? Like for example, for two turns, randomly possess nearby characters when hit. So there will be some window when the demon cannot possess someone, making the battle much more dynamic between offensive and defensive maneuvers.

The annoying part is even if it's a killing blow, the demon will still possess someone, making its corpse unlootable because it won't be exist after the last possession.

I specifically needed to evacuate all of my team and let the dwarf delivered the killing blow. It was obnoxious.
There seems to be another way to cheese it, but it isn't very efficient. The demon can only possess character in combat. After I had the demon leave the dwarf, I had my characters leave combat while summoned mobs attack him. It won't trigger the demon possesion while your character's not in combat.
The demon does not possess you if you are the only one in the party, or the only one alive. This worked easily for me on Tactician LW:

1. Bring dwarf's health down to 1 with Living on the Edge.
2. Have your strongest damage dealer kill your other party members.
3. Destroy all 4 pillars, and the demon will come out.
4. Kill the demon using your remaining party member. You can use Living on the Edge to easily keep the dwarf alive.