This is a long and complicated situation but I'll try to explain as briefly as I can!
MIL remarried 10 years ago. Step-FIL initially wowed the family with tales of successful businesses, survival from a rare deadly disease, travels to exotic places etc. There were some alarm bells in that he had no friends still on contact with him because "they all ganged up on him". He also came across as very manipulative and always shouted down anyone who dared question him. This was excused by him and MIL as being a result of his brilliant mind "he's just like that" etc.
Surprisingly (!) it turns out that all his wonderful stories are made up. It seems he is a serial fantasist and pathological liar with a penchant for emotional manipulation. For example he told us that MIL had cancer but that we weren't to ask her about it as she didn't want us worrying. She did not have cancer, but for three months we thought she did. He has also lied to get us to lend him significant amounts of money which haven't been returned.
He has also invested all of MIL's money in businesses which didn't work, (having lied about business experience) and has lost at least 250k, including their home. He and MIL have lived for many years in a remote part of the country away from all family because he said he was going blind and wanted to retire somewhere pretty. He is not going blind of course.
He has a daughter from a previous marriage who has PTSD, caused by childhood abuse at his hands. Two years ago she cut off all contact with him.
We have spoken to MIL about our concerns and she seems genuinely incapable of seeing a problem.
Things came to a head 18 months ago when they visited us and our 6 month old. Step-FIL took hold of her foot and whispered to her "you think you're in charge don't you? But you're not. I am." I went ballistic and they left. MIL still insisting he was misunderstood, joking, didn't see why we have a problem with him etc.
We are keen for MIL to have a relationship with her grandchildren and she visits several times a year without her husband (who is now banned from our house). On her last visit she asked us to explain to him why we have cut contact as he doesn't understand it. We feel this is an attempt to provoke a response out of us and stir the situation. We are expecting DC2 and realise that this will be leaving him feeling threatened because it will be another pull for MIL.
So, if you've got this far (!) what should we do? Respond with a clear letter stating we wish to not have a relationship with him or not enter into anything and ignore. Our main concern is that he might try to pretend he thinks everything is ok and gatecrash DC2's christening party for example. He is a very calculating man and we wouldn't put anything past him. But if we do enter into correspondence with him, he will twist whatever we say.