With a runner on first the batter is called out on a third strike that the catcher drops. The runner is encouraged to run to first thinking he's free to go. We know he can't because first base is occupied but the catcher throws to first anyways. The runner on first gets tagged out straying off first. Is the runner out? Is it a dead ball? What would be the correct call?
Both the batter and the runner on first is out. The batter is out on the dropped third strike and, like you said, he is not allowed to advance to first with someone already there unless there are two outs. On a dropped third strike the ball is still live and in play so the runner who got picked off first is also out.