Eight years with the company and three years as general manager should represent enough experience to handle this guy properly. The situation is unusual but not untenable. Begin by acting as if you assume that the old-new guy has solved all the problems he exhibited in the past, and recall each problem only if and when you assemble new evidence for it.
He left the business in a state of disrepair.
- Well, apparently the owner has forgiven him. You have repaired the damage. Anyway, you should have proper checks and controls in place so a person in his position cannot damage the business.
He was a yes man while he was in the GM role.
- Good. Now the old-new guy has to say yes to you. Just don't value his opinions until he says no a couple times.
You can be certain any conversation you had with him was reported back to the owner of the business.
- You can test for this by telling him a tracer (something harmless and unique, that the owner could not possibly learn from any other source, that the owner is sure to mention to you). If the old-new guy is still a tattler, now you have a clandestine channel of communication with the owner.
He used to be my boss and mentor. - Irrelevant. You both must ignore this. If he is insubordinate, deal only with the current insubordination. And remember, you did not advance by stepping on him. He moved himself from above you to below you.
His friendship with the owner I believe is a conflict of interest. - Not nearly as much as if the owner had hired his friend who used to be your subordinate as your new boss.
You are correct to be concerned that the old-new guy might think that he can climb over you. But he is in a very weak position to do this. He has already demonstrated that he couldn't do your job, and four jobs in the last three years is good evidence that he still can't. Let's hope that you don't have to remind the owner of all this.
Instead, he probably is terrified that you will try to get him fired. You should hasten to reassure him that this is not the case. He probably knows that you campaigned to prevent his re-hiring, so tell him that that campaign is over and you now concur with the owner's decision.
Most of the important information that you want to impart to the old-new guy will be conveyed by nonverbal sub-text, so you need to get your own attitude well settled before you talk to him for the first time. Once you firmly decide how you want to deal with him, it won't matter much what words you use.
I think you attitude should be, out of respect for the owner you are willing to give his friend a job. You wish the old-new guy well and want him to have a happy life as long as he doesn't mess with you.