Aeolius said:
And now the PC Group and LG group will have to join forces, to defeat a band of demonically-infused undead monstrosities comprised of fallen comrades from both of their parties....
FTW! At which point does the undead PC screw everybody over?
It doesn't make me a jerk?
Clearly you haven't DMed many evil games.

You are allowed to be as sneaky and rat bastard as you want to be. It's part of the appeal to that particular game style. IME when a group of players come to me and say "we wanna be evil", it's sign to me to put on my evil DM hat. FWIW, it sits next to my sandbox hat.
The five of us against you DM. Bring it. Let the smack talking and one-upsmanship begin. It's "gamism" at its finest. And it's a guarantee that the players want to muck with any "carefully laid DM plans" they sense.
I might be exaggerating a little, but these are IMO basic tropes of an evil game.
So the next time you find yourself asking "am I being a jerk?" pick a bigger weapon.
As a DM, I hate ruling that certain books or play styles can't be played. I feel like I'm pigeonholing the group into playing a game that won't be fun for them. I never know where to draw the line with what's allowed because I personally would be fine playing a game that only allowed the three core books and the PHBII, and I know that most people would not enjoy that.
I hope you can see how you put yourself in this situation where you're DMing an evil party and then posting about how you despise DMing evil games.
I also feel like it is simply my job as the DM to facilitate a good time for the party, and I don't feel like it will be fun for them if I don't let them play what they want.
Yes with a very important caveat: As a DM you have a greater amount of work to do for a game, so you have an equal or greater "right" to have fun. The best campaigns I've run and participated in were where the DM was having a blast. It became contagious.
Shoot, you've been playing with these guys for 20 years? I'm sure you guys can work out a middle ground.
Thanks for the ideas on how to handle the situation. The more I thought about it today, I guess the town is really more neutral-aligned and relatively impartial to what the numerous adventuring groups that come and go do so long as the locals don't get hurt. I feel like I can just cut them off from some basic services and force them to live in the wilderness and find somewhere else to trade their goods. I'm within my rights to have the town react this way, ya?
Of course you are, but I think your particular idea ("we won't sell to you") is off the mark. Why? Because the main contribution PCs make to settlements, especially evil PCs, is cold hard gold, and the peasants don't want to cut themselves off from that -- it would be like a city turning down the Olympics!. A good question to ask is what has the PC swordsage contributed to the town compared to the NPC paladin?
For example, the swordsage just dropped 5,000 gp at the local smithy, rents a luxurious room at the inn, and frequents the tavern and brothel. He and his buddies may have accidentally taken out the town's criminal kingpin for which the townsfolk are grateful for. Who knew?
The paladin has embodied the precept of Heironeous "duty to the people" by defending them from overwhelming evil, restoring stolen cattle from bandits, and exonerating a falsely accused man. Naturally, he donates heavily to the local temple and has friends among the city watch.
What does the town think of them?
Craftsmen, inn-keepers, brew-masters and whores are lining up for the PCs' business. The loss of the paladin was no big deal for them, as those paladins are always coming back from war with dirty halos, ready to make conflict where there is none.
On the other hand, folk further from the PCs money -- shepherds, farmers, the temple, guardsmen, and such -- are appalled and outraged. Here was a paladin who protected them, sacrificed for them, and was rewarded for it with a dishonorable death.
A more likely reaction from the town would be: The church condones the PCs and demands the local lord arrest and punish them - in fact, several guardsmen are more than eager to do so!
However, there are mixed reports of just what happened at the tavern.
A passing cleric says the PC stabbed the paladin in the back in cold blood (but he was looking thru a window), an off-duty guardsman claims the PCs started it (but he was drunk), two farmers swear the PC worked evil magic and teleported behind the paladin (but they're the same ones who were complaining about that so-called "vampire" last year), and the shepherd's son (who wasn't supposed to be anywhere near the tavern) is keeping quiet even though he admired the paladin.
The inn-keeper swears the accused PC is harmless as a fly, the brew-master says the paladin NPC started it, a whore claims the PC couldn't have done it cause he was with her, maybe a local craftsman offers to swear false testimony in favor of the PCs in exchange for the paladin's treasure?
The lord is nobody's fool. He's got to find a way to make both sides happy.
And the surest way to do that, for the lowest cost, is to prove the paladin wasn't as 'holy' as he pretended to be. IOW a spin campaign. Maybe this works in the lord's favor as it takes the power of the local church down a peg, something he's been trying to do for years. If the lord is brazen, he might try to extort the PCs for money to "clear their names."
As a plan B, if tarnishing the paladin's reputation doesn't work, is to get rid of the party as expediently as possible; the lord's preferred method for this sort of thing is to send them on a quest for "untold fortune" in the lair of the most deadly monster in a 100 mile radius.