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Of course your Rep. won't drop to 0, especially if you're a Paladin. True, you CAN avoid this fight entirely (if you do avoid it, then 6 dudes will dress up like your party and then kill the bad guys, framing you for their deaths), but I wouldn't suggest it, because by whacking them, you at least get the Exp. and some loot.
BioWare wouldn't have the game hint so strongly towards "Find the Leaders of the Iron Throne and kill them" if doing so would turn you into a Fallen Paladin and take away all your spells.
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