The creature the party faces is not a "stock" grig. It's originally a home-made fey, I just used grig as a kind of "template" to assess power level. I call these creatures "microelves."
Myshnue has a much higher dexterity than the average grig (meaning 18 + racial modifier = 26).
The description of this creature is revolving around one fact: he is fast. Like, crazy fast. Like, mind blowingly crazy fast. Thus, he has, among others, improved initiative, and he has an extraordinary ability similar to PF's Cheetah's Sprint that he can use to jump great distances with blazing speed.
He also has class levels (hint: what class levels may a character have if he attempts cutting a purse without the owner (an elf) noticing?).
Similar to grigs, the creature can become invisible and alter (not disguise) himself as a tiny elf (and only in that form).

Myshnue approached the party invisibly. AFAIK nobody has the power to see invisible and even Giant's blinking wouldn't achieve that feat, even though ethereal creatures are invisible on material.
He moved so silently that everyone missed him. For Boo, in particular, I rolled a natural 1 and decided that it would manifest in him being distracted by something in the water (this was just fluff, nothing more)
When he approached Merri and took a kind of offensive action (sleight of hands) his invisibility dropped. I rolled spot for everyone and only Toot noticed him. The extremely high Nature and Will rolls enabled the jermlaine (also fey on their own right) to notice the grig-like facial features (eyebrows resembling antennae) on the altered form and realised it must be a fey similar to grigs.
I also rolled a perception (wisdom) check for Merri to see if she notices being robbed but she failed.

First I considered that since Myshnue approached first he cannot be flat-footed in the first place but then decided, why not, especially because it gave a good opportunity to see how the fey druid of the party would react to a fey in a sylvan setting. So I called for initiatives.
Toot won initiative (14+3 vs 1+12) and decided to try the peaceful way of interaction but minimise risk by letting the creature get away so readied a standard action (partial charge) for the case "if the Grig (or so he thought) attempts to do anything aggressive or tries to escape".
The initiative of Myshnue came and he took three actions:
1. Speak (free)
2. Dismiss the spell (well. Thought it was a free action or no-action but apparently it's true only for concentration spells, otherwise it's a standard action.)
3. Escape by extraordinary jump (swift action).
Of these, the first two did not fulfil Toot's conditions specified for the readied partial charge but the third did.
Thus, the creature was not flat-footed (since he's already taken two actions in the surprise round) but had to suffer the consequences of the readied partial charge.
Note that even if he would've been flat-footed his class levels would've granted him to retain his full dexterity bonus. (fun fact: uncanny dodge doesn't say you are not flat-footed. It says you are flat-footed but you retain your dex bonus. I can see one difference here: you cannot make AOO while flat-footed, but there may be others.)

Step 1. Toot approached and had to enter the creature's space. Normally, leaving a threatened square provokes AOO but since Myshnue is tiny, he doesn't threaten squares. However, entering a creature's space also triggers an AOO (question: for S/M/L/etc does this mean two AOO's if the defender has Combat Reflexes?). Do tell me if I'm wrong here. Anyway, I rolled a 5 and even with his finesse and size bonus and everything it's waaay too small to beat Toot's brand new AC (what, 25 when charging or so?)
Step 2. Touch attack. Now, Toot had to beat the touch AC which is 10+2(size)+8(dex). He failed, meaning he could not interrupt the action in time.
Step 3. It didn't come to pass but Toot's roll is correctly 16-6 = 10, would've been sufficient to beat Myshnue's roll of 17-8 = 9.
Note that I recalled that defender can select either dex or str for an opposed grapple check (Myshnue would have +3 instead of -8) but cannot find where this idea came from. First I thought it came from PF's CMD but there you add both.