Eventually, this individual holds the workplace hostage. Everyone is walking on eggshells so not to be the one who ticks off the bully. This person may or may not have a mental illness. The point is that the performance problems, rude and inappropriate treatment of co-workers and the insubordination were never addressed. They should have been addressed at the first instance and every instance thereafter.
Managers can do the company a great service just by noticing behavior.
You did not address the problem at the first instance. If an issue continues after the first time it is noticed, it becomes an issue that needs to be addressed through the disciplinary process. This is also the key to managing mental illness in the workplace. The manager does not diagnose or assess the psychiatric disorder. He or she simply monitors and documents work performance and communicates expectations and directives to employees.