The Undercity was so named many years before the Forsaken claimed it as their own. Far beneath the palace of Lordaeron, the Undercity held the ancient crypts and catacombs of Lordaeron's royalty, as well as the city's dungeons and sewers. Although the Undercity was only intended for prisoners and the dead, the poorest of the Lordearon people lived within. When the Alliance captured Orgrim Doomhammer, they sent him to the Undercity; sometime later he managed to escape and wandered for many years afterwards.
Lordaeron's capital city stood for centuries, a monument to humanity's might. In the Third War, Prince Arthas slew his father, King Terenas, in Lordaeron’s throne room and ransacked the city. He planned to use Lordaeron as his capital on this continent and ordered his minions to expand the catacombs beneath the city. Then the Lich King summoned Arthas to Northrend and the work was left uncompleted.
During Arthas' exodus, Sylvanas Windrunner broke free of the Lich King’s control and took many banshees and other undead with her. With Varimathras' assistance she defeated the dreadlords that controlled the city and set her newly dubbed Forsaken to finish Arthas' job in the dungeons. The Forsaken carved the Undercity and now rule the surrounding countryside.
Wrath of the Lich King
While the forces of the Horde and the Alliance were concentrated on a joint effort at Angrathar the Wrathgate, an uprising broke out within the Undercity. Demons of the Burning Legion and Forsaken rebels led by the dreadlord Varimathras and Grand Apothecary Putress managed to take control of the Undercity, killing several Forsaken and nearly killing the Dark Lady as well. In response the Horde led by Sylvanas Windrunner and Warchief Thrall attacked from the front entrance to reclaim the city. While the Alliance led by Varian and Jaina attacked from Sewers to restore Lordaeron to the Alliance. The ensuing battle ultimately killed both Varimathras and Putress, along with their fellow demons and Forsaken rebels.
However being no stranger to broken dreams, it is only fitting that Lordaeron bore witness to the end of the Horde-Alliance treaty as King Varian declared war upon the Horde after seeing the status of the once proud city. Jaina subsequently teleported the Alliance back to Stormwind.
With Patch 3.3.0, Thrall sent a legion of Kor'kron Guard led by captain Bragor Bloodfist, who replaced Varimathras, with Kor'kron Overseers replacing the Undercity Guardians, in order to ensure that the events of the Battle of Angrathar the Wrathgate never occur again. Some guardians still remain in the Sewers; it's unknown if this is an error or not.
The Undercity is an extension of the crypts and dungeons originally beneath Lordaeron's capital city. The Forsaken dredged out complex catacombs and caverns. The place is dark, smells of corpses and has an evil feel. Spiders, oozes and other subterranean creatures occupy the distant passages. It is drastically different from any of the other capital cities for the Horde. Unlike Thunder Bluff and Orgrimmar, which are at the surface and often the sites of multiple festivals, the Undercity is dark, dreary, and cold. The Forsaken, however, are known for holding two festivals, Hallow's End and Pilgrim's Bounty.