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This technique worked for me as well: Kill 3 out of 4 chains, 'kill' dwarf until red explosion pops (the dwarf has a buff that prevents him from dying, so just hit him), heal dwarf back up and give him physical and magical armor, then summon a high level incarnate, hide your party, have incarnate kill the last pillar and then the demon. You can complete the quest by talking to the ethereal priest. The only thing you miss out on is that the dwarf reveals his treasure to you (apparently he would only talk to your incarnate... lol)... but that treasure isn't even worth picking up and you can find it with high wits anyway.
Just kill the dwarf. The XP reward isn't that good and the fight is a GIANT pain in the *** - and very buggy. Sometimes you'll kill the spirit only for it to stay at 1hp instead of dying and hop into *another* teammate. It uses up all of your consumables and the reward is two fking gold.

I mean if you like to RP and aren't just playing this game trying to maximise your rewards then saving the dwarf is the best course of action. (If you're good aligned).
"It can possess any of your teammates within around 8m range." Hum, no 13meters.
I came here with a level 13 team, it possess a member of the team maybe 75% of time I deal damages to him (if a member is in range).
Maybe he cannot do that so easily with a better ranked team?
So, I'm into act IV, on an Island I Won'T Name so I don't spoil anything, but Sebille still has the demonic invasion tag she picked up in this fight. Like my night with a street walker, some bugs are for life, I guess.
Fun Fact: If you use source vampirism on the corpse of the demon afterward your character gets possessed again
All right Mor the Trenchmouthed, I get it. You can possess my teamates, that's cool. What isn't cool is that you do it randomly. Even when its not your turn. Also, You wasted all of my charm grenades on my team too. Not cool man.
He can do it when its not his turn? I can do you one better. He can do it when hes dead and when he stops possessing them, he just doesn't exist.
You can freely kill the dwarf after saving him for another 28900 XP.
This fight is very ****. Demon control of char isn't part of the demon skills, instead it seems as there some trigger which automatically remove demon from battlefield and then take control over PC. So you may not even needed to fight the demon, just walk away from the edge of the pit and teleport demon into the pit, where trigger mounted on him wouldn't be able to reach your chars, since it seems as it working by >take damage>pick nearest visibly character>remove demon/apply control, - logic. But be careful, because of **** nature of this fight design, if you kill demon that way, he may still take control over your chars if they come close to the corpse of demon (since it seems as trigger is not auto-disabling itself if quest is complete). I my party trashed this demon that way, one of chars went down to eat demon corpse for source point. but after he cast source vampirism, combat started and he got himself controlled ;/
I found a way to cheese this fight while saving the dwarf. Two characters (lone wolf), one high level summoning. Got the dwarf down to low health and all but one totem destroyed, one toon hangs way back the other, my summoner, pulls down a blood incarnate, power infuses, summons 2 blood totems then destroys the last pillar. Demon pops up and the summoner goes first, teleports the dwarf far from the action (to avoid nether swapping), then that characters runs away from the ledge. The incarnate and the totems take down the demon while my two guys focus on teleporting the dwarf to the far far edge of the chamber. Demon dies, only summons nearby and it possesses: Nothing!
The way I did it was to have my party at the statue outside the chamber and a colossal incarnate in the pit. The only member of my party that was in the fight sequence was my necromancer who could just cast blood storm from the statue and kill the demon with help from the incarnate. I think this method avoids a bug that occurs when no party members are in the fight.