Thank you all for the replies. We are honestly trying to keep our spines firm on this, I know we haven't done the best in the past. It's easier to know in my mind what the right thing is, than to actually make myself enforce it. I do sympathize with MIL and understand why she won't cut BIL off.. she had a sibling with very similar issues who took his own life, so I think that she's afraid if she just cuts him off, the same thing will happen. Still doesn't change the fact that we need to protect our children (and ourselves) from the situation.
I agree that DH going to the birthday dinner was a step backward. What had happened was, DH had called her earlier in the week and asked her to meet us at X restaurant. He made it VERY clear that the invitation was for her, and for her alone. We thought that she got it, but then, 30 mins before we were supposed to be at the restaurant, she called us and said, "Hey, we are already here if you all wanted to head up a little earlier..". We, being her and BIL.
This was really the first time that we had explicitly stated that BIL was not welcome. I refused to go, and refused to bring the boys. It's hard to explain but DH did not want to get in a huge fight (and it would have been) on his birthday. We agreed that he would go alone, and call MIL in the next day or two to explain (again) our position. Shouldn't have been necessary, but apparently the first time didn't sink in.
I just talked to DH.. he is going to call her tonight, and just say "We're not going to be there on Thursday, but we'd love for you to come to our house on Saturday for dinner. Please remember that this is an invitation for YOU."
I know that we come off as weak here.. it's just hard to consider cutting MIL off if that is what this has to come to. DH's family is REALLY small.. as in, DH, BIL, MIL. I know DH doesn't want to leave MIL all alone. Despite her manipulations and intentional blinders where BIL is involved, she really is a good person and we very much want to maintain a relationship with her, for her sake, our sake, and for our boys' sake. Just have to get it across to her that for now anyway, that relationship can't and won't include BIL.