Created following a slave rebellion in 1817, Bloody Bay was always known as an island of rebellion. They refused to be associated with the Rogue Isles, and even when the Isles were assimilated by Arachnos in the 1960's, the citizens refused to acknowledge their dominance. A bitter understanding was eventually struck with Lord Recluse that gave Bloody Bay autonomy as long as they did not work to undermine Arachnos control elsewhere.
In 1989, the island was hit by strange meteors from the stellar being known as "Shiva". These strange meteors did not cause as much damage as initially feared, however the strange radiation from the meteors did animate the nearby corpses into huge hulking creatures of protoplasm and bone. Once defeated, though, more and more of these "Shivans" would appear. It became clear that there was more to these meteors than just inanimate rock.
Unable to clear the meteors from the area, Lord Recluse ordered the immediate evacuation of Bloody Bay. The United Nations eventually quarantined the area for further research. Many of the refugees took refuge in Paragon City.
In recent years, though, interest in the mystery surrounding the Shivans resumed by both Longbow and Arachnos forces. Research bases were set up and teams would be routinely sent out to gather intelligence and samples.
The history of Bloody Bay was explained in Issue #3 of the "Golden Girl Comics" series.
(Please check out its Paragon Wiki entry for more information.)