Opinions please

You know you're a great guy Rusty, so as tough as it may seem I'd chalk it up to life experience, eat the $200 and give him the engine back. Since you don't know how the water got in the crankcase, I'd just give it back to him and hope his machinist charges him $500 to hot tank it and tell him the block is cracked. Just make sure this jerk doesn't go around telling everyone how you "gave" him a cracked block. You just can't make some people happy..... I'm sure he's related to my ex!