In this case...
I, personally, would have left the paladin dead. It is VERY obvious that the players have lost all sense of the omnipresent chance of death. The party forged on even when they were low on hit points, and apparently low on healing. They make the risk that they would be ok, they lost. One of their party was killed because of it. You didn't do anything wrong in DMing, the players chose their fate. They wanted to take the risks, and they lost, big time. Too bad. You can't expect to just heedlessly throw yourself into combat while low on hit points and expect to always get out of combat spotlessly. The players were stupid, and they paid for it. I feel bad for the paladin, especially since he was a good role player, but his actions were unwise, and in a life or death game, that meant the death of his character.
I, personally, would have left the paladin dead. It is VERY obvious that the players have lost all sense of the omnipresent chance of death. The party forged on even when they were low on hit points, and apparently low on healing. They make the risk that they would be ok, they lost. One of their party was killed because of it. You didn't do anything wrong in DMing, the players chose their fate. They wanted to take the risks, and they lost, big time. Too bad. You can't expect to just heedlessly throw yourself into combat while low on hit points and expect to always get out of combat spotlessly. The players were stupid, and they paid for it. I feel bad for the paladin, especially since he was a good role player, but his actions were unwise, and in a life or death game, that meant the death of his character.