SPOILERS contained
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I'm fairly certain that this is an "evil" option.. meaning that you have to be evil in order to deal with the demons. In my game I was able to deal with the tanar'ri (and amazingly enough, he actually followed through with his end of the bargain). I'm pretty sure that I would have been able to deal with the baatezu as well. You also get experience by completing the deal - so it isn't as if you completely lose out on the experience by not killing one of them.
I've tried - and beaten the game with the improved bhaalspawn mods, and yes there is a multiple dragon fight (what a mess
). If you're interested in a challenge, download and try them, but I'd suggest keeping a backup of the files involved just in case.