Demon Lord's goal is to bring peace between all of the races, so her decision to not kill Feline Freak is a sound one. It's not naive when you don't kill your opponent in this case.
However, the decision to not kill him did result in him summoning that overgrown puppy. "Why didn't anyone restrain Feline Freak before he could do that?" you might ask. The answer to that is, they didn't have the chance.
Hiiro was about to kill him, then Demon Lord and her red haired subordinate came to talk him out of it, then IMMEDIATELY after Hiiro agreed to it, Feline Freak delivers his speech and summoned that puppy.
I'm guessing she was going to order someone to restrain Feline Freak right after Hiiro agreed to not kill him, but Feline Freak is faster and took action first.
And not to mention that everyone must've thought he doesn't have enough strength to do anything anymore.