...Paladins would have trouble with this and I believe knigts are forbidden from this type of behaviour (never strike a flat-footed opponent...*never deal lethal damage to a helpless foe)...
(*added by me)
True. It is a part of the Knight Classes Code, but it isn't a part of the Paladin Classes Code, though probably within the spirit of the Paladins code. I do find it ironic that the code of the Knight class is actually more restrictive than the Paladin.
However, I have a problem with this view of
coup de grace (not your post
irdeggman, the RAW in the Knight class and in the game in general).
The historical
coup de grace was an act of mercy performed by Knights (common soldiers simply didn't care, chivalry and honor was much less important to them than a Knight). It's literal translation is
blow of mercy, and it was actually considered a Knightly/Chivalric virtue (Mercy). It was intended to end the suffering of a dying or extensively wounded opponent (especially when medical attention was inaccessable). Mostly, it was for other Knights and Nobles and not common soldiers, but a particularly honorable and empathetic Knight might extend the courtesy to a non-Knight/Noble. Typically, if a Knight or Noble wasn't dying (or severely injured with no chance of medical intervention), they would be taken hostage rather than being killed (for political or monetary advantage - ransom). The concept of not killing a defenseless foe was more to encourage the above behavior, it was not intended to stay the hand of a Knight from providing mercy to a dying opponent.
In the case of the OP's Goblins, and if the character was a Knight or Paladin, from a European standpoint they are monsters (not Knights or Nobles), and therefore not deserving of such considerations. However, a particularly empathetic Paladin or Knight may have a problem with this based on their own personal code. But, a typical Knight from the chivalric stories of the Middle Ages would probably just kill all of them. They are monsters. Chivalry does not apply.
However, since it is a
D&D world we're talking about, I would say that if the Goblins were wounded or dying (and not able to recieve medical or magical attention, using highly valuable magical healing on the Goblins would not be expected nor required) then killing them with a
coup de grace would be okay, and actually expected. If ,however, they were only asleep (due to the magic) and not dying (and therefore could wake up and live the rest of their life), then killing them would probably violate a Knights code (and probably the spirit of a Paladins code). A non-Knight/Paladin character however, has no such code - no such moral restrictions. If the character feels that it's okay (they're just monsters...) then I would rule that it's not an evil act. Also, as the name implies (
blow of mercy), I would rule that killing them as they sleep would be much more merciful than the pain and suffering they would endure if killed during combat. Also, I don't necessarily consider them
defenseless even though they are asleep. Once awake, they will be just as much of a threat as they were before. As far as PC's are concerned, Goblins are monsters that do nothing but kill without mercy. Killing them in their sleep is the most merciful way of accomplishing the necessary action of removing the threat they represent.
As for the codes (the Paladins and Knights codes), in my games I use them for what they were supposed to be: not as a set of black-and-white requrements, but as a set of guidelines that such characters use to make the value judgements and decisions that are integral to these characters ethos. If they are continuously and honestly evaluating their actions based on these codes, then I really have no problem with any of their choices. If they however, start using their interpretations of these codes to justify things (and you'll know the difference when your players do this), then they have violated their code and should suffer the consequences.