what is the proper protocol

I would return the buyer's funds. The seller is responsible for the item until it is delivered to the buyer. --This is how I do business. I have taken to asking sellers (when I am buying) what their policy is should an item be damaged or lost in shipping, so that there can be no misunderstandings.

With out a doubt, I would wait to be reimbursed from the shipping company. This is only fair. Otherwise the package could be found and delivered.