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Ah, saying it now sounds embarrassing, but it was a short-sighted design on my end. After the "First Act," you're meant to be able to recruit human units, which you can actually heal using potions and the like, but as you say, it is extremely misleading to the player to give them potions when they can't use them in the beginning.

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Would it break the game balance to have the Undead get life back for the damage they do? Say as a passive ability or use soul energy to heal. In D&D Undead heal from Negative energy; maybe something like that?

Ooooh, that's a good idea! A passive ability for all Undead units like that would be really cool :D

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Glad I could help!