That's an interesting scenario where a large short decides to...

That's an interesting scenario where a large short decides to make a takeover bid. Do they have to return the stock? Well, the usual process for takeovers is that the directors reject (so nothing happens) or recommend that it gets put to the shareholders to vote. The holder of the voting stock gets to vote... you don't vote if you lent out your shares, hence it is also the case that the original owner recalls the stock so they can vote it. Now, unless the takeover bidder has some shares available to return, they will have to get some by buying in the market or perhaps trying to borrow from someone else. Borrowing from someone else is unlikely because all the owners would like to vote stock, which leaves the takeover bidder having to cover in the market. This covering for recalls may drive the price higher than the bid (or not).

I think the only time you don't have to return stock is if the company gets liquidated and declared worthless (but will have to check that). I know from experience that having a busted short declared worthless can take several years(!), so a shorter doesn't _really_ want the company to go into suspension whilst still short... better is for it to fall to 0.001 and cover.