Hi L., I'd have a different approach to the other posters (not surprisingly, tehehe).
You don't mention your FIL's age. But with several mental and medical conditions it sounds to me like you may not have this problem much longer.
A bipolar addict CANNOT empathize with any consistency how his behavior effects loved ones. He is singularly narcissitic (sp). "consequences" for his actions as you put it will have no effect, this is apparent as his wife has been enabling him their entire marriage. (I only know these things having been married to one myself, and having been an enabler my entire marriage, until I left)
It's unfortunate that you did not realize these things before the arrangement took place.
Prepare yourself for an ENORMOUS FAMILY WIDE falling out if you decide they have to go, the verbal agreement has to be broken, this includes your relationship with your husband who has probably grown up an enabler and doesn't even recognize it in himself. He may be SHOCKED that your tolerance level is not the same as his.
You are the "Lady" of the house, there by are effected the most by the behavior of everyone else in the house. You are also a Mom and determined to bring your children up in the best possible environment.
To be honest, with respect to the potential explosive posibilities of the arrangement, you may need some professional help on your side. Well your husband go with you to a visit with a therapist? Or even to a AA meeting? My point is, the THREE of them are very accustomed to banding together against 'outsiders' who refuse to enable the dysfunction.
Soooo, is it worth it to you? A wiff of cigarette smoke from time to time? Or is their dysfunction ALREADY effecting you and your kids and your marriage? Is it really just about the smoking?
Sorry, just more questions, and no real answers for you.
What does your husband think you should do?