I'm a bit puzzled about how PayPal can legally suck the money back out of your account for this. Technically if your PayPal account shows a negative balance they've lent you the money, and so fall under the FSA regulations.
You never signed a credit agreement with PayPal, and if you inform them that the debt is in dispute they're on very thin ground if they try to take the money without your permission or send in debt collectors.
Stop the card, wait to see if you actually get the phone back (I bet you won't), then report the buyer to the police for theft and ask PayPal to take you to Court for the money. If they send debt collectors after this, you might want to report both PayPal and the debt collectors to the police too.
Worst case? You have a day in Court, lose, and have to pay minor costs.
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