It's possible for the DM to have set up a terrible play scenario and for the Paladin to have not acted good during it. The one doesn't excuse the other.
I firmly believe the DM shouldn't have used this scenario. I also firmly believe the Paladin did not act good in this instance. What's your argument that what he did was good?
(Keep I'm mind I'm not calling the Paladin evil in this instance, just not good)
I am not arguing that what he was good. I don't think it was wholly evil either. Probably neutral "I will save my life for something greater because I have no realistic recourse to save this innocent".
The paladin got mugged and gave in. It sucks. Kobayashi Maru scenarios typically do. The dragon is still responsible for the death. It took the overt actions leading to it.
My argument is really twofold. (1) Blaming the paladin for the death is blaming the mugging victim for being mugged. (2) Just as it is incumbent on every player to play well with others regardless of "what the character would do" it is incumbent on the DM to play well with others regardless of "what the universe would do". This does not mean all failings need to be glossed over or that falls cannot happen. It does mean that if you arrange a no-win scenario without intending such, you need to clean up the mess because no one else can. And if you arrange a scenario and think there is a win if the player does the exact one thing you're thinking of, that's generally a no-win scenario.