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Seller cancelled my order

Bid on set of 3 items. Won bid. 2 days later seller advised me they had dropped 1 of 3 items and was "absolutely sure,  it would be fine or they could cancel the order.  I replied and asked how damaged it was, 

that they could send a pic of damage or that if they would compensate for the damaged one, I would still take other 2.  They did not reply to that message and cancelled the order and refunded my money.    I dont know what kind of game they are playing.   Should I report seller to EBAY?  Why even offer an item if you don't intend to sell it when it is won?  

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Seller cancelled my order

S/he reported him/herself.  The seller already got a "defect" when s/he cancelled the transaction (unless s/he lied to eBay to blame you, in which case we'd need details especially what eBay said the reason was in the cancellation notice). That is the primary tool eBay uses to weed out bad sellers, downgrading the selling status of those who get too many relative to their sales volume (as opposed to having to pay employees to actually investigate to see how likely it was that the seller had a legitimate reason to cancel vs. deliberate policy violations).

You may leave appropriate (calm, factual--if the seller said that x was the reason say "seller said x. . ." so people don't think you are just jumping to conclusions) feedback to warn future buyers/bidders. If the usual links have vanished, go to anyone's Feedback Profile (doesn't matter who, click on the feedback score in parentheses behind the username) then scroll down to below the last comment on that page to find a "Leave feedback" link that doesn't vanish (it brings you to a list of items you can leave feedback for).

Theoretically you could sue the seller for breach of the contract of sale (for the difference between the auction price and what you ended up having to pay for a replacement), but that is almost never practical.

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