What should I have done when he did that?
What do I do next?
Why is he showing possesion agression with this friend? or is it just bad luck she has been the brunt of it.
If he is inconsistent - is this going to be a problem?
1. If you saw the situation developing, I would have warned the firend to leave him alone. If you didn't see anything till the actual bite, I think I'd have given him a sharp "ah-ah", and made him come to me and sit/stay, or something like that. If you didn't see anything till after it was over, I would, calmly as you can, call him over to you and make him do a sit stay. After a couple of minutes, or however long he can handle stay, release him to go lie down or go outside or something to defuse the situation.
2. What next? Your friend needs to be gently reminded how to be around dogs. She may be used to them but she's not very perceptive about handling them. She sounds like she's very "in-your-face" with Paddy, and while she means it affectionately, he doesn't always see it that way. With most all dogs and visitors of any species, human or otherwise, it is the owners responsibility to keep a sideways eye on what is going on with the dog and be ready to firmly intervene if a problem appears to be brewing, or if anyone is doing anything that could start a problem.
3. However much you see her, and Paddy has stayed with her, she is not, in Paddy's eyes, part of the "inner circle" of your family, so he's not going to tolerate the same things that he lets you and your family do. And I gather when you said he has stayed with her that it was at her house. This time he was on his own turf, in his own bed. Again, as others have said, she is too pushy with him, while she means well, he may feel a little crowded and overwhelmed. For example, you may be great friends with your next door neighbour, but you would never allow that person to kiss you in your bed or while you were doing something! We have to allow dogs to have some personal boundaries too, and enforce those boundaries around other people, much as you would for your own child.
Her daughter sees how her mother acts around Paddy and probably does the same to him, overwhelms him with affection. Also, if he is staying in someone elses home, he may be a little off balance and worried or stressed, which may make his behaviour less than sterling.
4. I don't think Paddy is inconsisent at all. As I said, it is our job as owners to protect our dogs personal boundaries as the only few means they have of doing it for themselves is growling and biting. (And never underestimate a dog, they do know what they are doing and how much jaw pressure to exert. If Paddy had truly meant harm, he would have done so. That was a very stern warning bite, and it may be hard to fathom, but he was showing a great deal of control in the situation. He went for her hand, not her face, and he put just enough pressure to get his message across loud and clear, since his first warning was ignored)
Do get the books recommended, they are excellent, and as well you may want to get "Canine Body Language" by Brenda Aloff.
I know it's very shocking when it happens, but when you pick it apart you can see a certain logic to it. I don't think theres anything "wrong" with Paddy, you just need to take into account that he can only be pushed so far and you need to intervene before that point is reached.
As far as your friend trusting him again, only you will know how to talk to her to get her to understand how to be around Paddy, and gently lead her toward her own realization that she caused the problem.
Now go give Paddy a big kiss
(Just make sure he's awake!
)