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I would just do a 402(g) excess distribution from the account. Normal earnings calc would apply (sometimes the carrier will do it, sometimes the TPA calculates it). He gets all the money back (withholding is optional). It will generate a 2018 tax form, so he'll pay taxes on it. And you don't mess with payroll.

At the risk of being a bit too "geeky" here, it is worth noting that a loan must be "bona fide" to be treated as a loan under IRC §72 (see Treas. Reg. §1-72(p)-1 Q&A 17). If the business owner took the funds with the intent to not pay them back, then there was no bona fide loan and the plan has an operational failure and a failure to withhold taxes on a distribution. Given that a HCE/Key EE was the party that took a distribution in violation of the plan's terms (and probably in violation of the 401(k) distribution restrictions), this could be a qualification issue.