What would make a guitar unable to play above the fourth fret, and how can it be fixed?

Well, sounds like it's badly out of adjustment. That's about as far as I'm prepared to go on the basis of a vague secondhand description. There are only two things that can be done by someone inexperienced with guitar repair. The first is to make sure the guitar is tuned to standard pitch. And if the guitar is electric or has an adjustable saddle, they can try raising the action (string height) by raising the sadde slightly. However, there may also be problems with the neck curvature and this is not a DIY job.

A full setup usually costs $35 -75. A tech might do minor adjustments for less, but it all depends on what they find when they inspect the thing.

As to what to do, it depends on the circumstances. Was the guitar working right when you sold it to them? If so, it's their responsibility now. If not, or if you didn't know, did you sell it to them "as is", with the clear understanding that it might need work? In that case, again, it's their responsibility.

If they had a reasonable expectation of it working, or even if there's any doubt about the matter, my suggestion would be to just take the thing back and refund their money. Your reputation for fair dealing is worth more than a few bucks for an old guitar. And trying to coordinate rrepair work with someone else is going to be much more hassle than it's worth, and likely to prove unsatisfactory for everyone.

The action is either too low or the frets are not levelled properly. You or the person you sold it to should take it to a guitar shop and have the guys there give the guitar a proper set-up. If it's just a low action that's pretty cheap to remedy, $10-$15. If the frets need levelling that's a bit more, $50-$80.

The action is too low. The trick with raising the action however is that the intonation will then need to be adjusted. These are common adjustments that every guitar needs. Fret leveling and crowning is also a good idea. And to add...did he not play it before buying it? If you sold it to him with under the pretense that it was playable, then I'd pay to have the action set and intonated. I wouldn't pay for fret work.