If you have bad knees, take care of them. First question is "how bad is bad?" Have you had previous injuries or surgeries on them (if so, how severe?), or just general soreness, etc?
You can do martial arts with bad knees, and can even turn relatively bad knees into good ones. When you start any program, keep in mind that you're working towards long-term goals. If something looks like it might damage your knees, don't do it (or alternately, do it but to a lesser extent... ie if the class is doing lunges, you might decide to do partial ones). Listen to your body... it will be pretty good at telling you when you've done something wrong. Continuing to push at that point is a sure path to injury.
In the meantime, you can investigate a number of supporting activities that, over time, will strengthen your knees and make them "better" (maybe not completely, but likely better than they are now). One of these might be specific weight training (strengthening the supporting muscles can go a long way). Bike riding (stationary or outdoors) may also help as it's a low impact activity that will strengthen the muscles. Here, the advice of a good physiotherapist would be hugely beneficial.
On a personal note, I did have a torn ACL and meniscus in my knee, and had surgery on it about 3 years ago. It took about a year to "fully" recover to close to its former state, and has continued to improve past that to the point where I feel comfortable doing deep squats, sprinting, and jumps on it and I know it is now stronger than it was before the injury. The point is to keep making gradual improvements.
Let the instructor know what the issues are going into the program, and see what his recommendations are. Let him know that if you think a technique is too risky to your own health to perform it, you will decline (for now), but also let him know that one of your goals is to improve in these areas. In all likelihood, he'll know how to work around your limitations. If not, then perhaps seeking a different school would be best for you.
As your strength improves, so will your confidence, and some of the activities that you look at now and think would destroy your knees can actually become do-able. You may never be the best person in the group at doing jumping 270 degree spinning kicks, but martial arts is about way way more than that.
