After World War I and the demise of Austria-Hungary the question of the status of Rijeka became a major international problem. At the height of the dispute between the Kingdom of Serbs, Croats and Slovenes (later the Kingdom of Yugoslavia) and the Kingdom of Italy, the Powers advocated the establishment of an independent buffer state. The American president Woodrow Wilson became the arbiter in the Yugoslav-Italian dispute over the city. He suggested that Rijeka be set up as an independent state and as the potential home for the League of Nations organization.

The dispute over the city led to lawlessness and the city changed hands between a South-Slav National Committee and an Italian National Council, leading finally to the landing of British and French troops who took over the city. This confusing situation was exploited by the Italian poet Gabriele D'Annunzio who entered the city with his anarcho-fascist movement on 12 September 1919 and began a 15-month period of rule. A year later after failure of negotiations with the Italian government D'Annunzio proclaimed the Italian Regency of Carnaro.

On 12 November 1920, the Kingdom of Italy and the Kingdom of Serbs, Croats and Slovenes signed the Treaty of Rapallo by which both parties agreed to acknowledge "the complete freedom and independence of the State of Fiume and oblige to respect it for eternity". With this act the "Free State of Fiume" was created, which, it turned out, would exist as an independent state for about one year de facto, and four years de jure. The newly created state was immediately recognized by the United States, France and the United Kingdom. D'Annunzio refused to acknowledge the Agreement and was expelled from the city by the regular forces of the Italian Army, in the" Bloody Christmas" from the 24th to the 30th of December 1920.

In April 1921 the first parliamentary elections were held which were contested by the autonomists and the pro-Italian National Bloc. The Autonomy Party, which was supported by votes from the majority of the Croats, gained 6558 votes, while the National Bloc, composed of Fascist, Liberal and Democratic parties, got 3443 votes. The leader of the Autonomy Party, Riccardo Zanella, became the President of the Government.

On 3 March 1922 the fascists carried out a coup d'état and the legal government escaped to Kraljevica.

In January 1924 the Kingdom of Serbs, Croats and Slovenes, through the Rome Agreement, agreed to the annexation of the city by Italy, which took effect on 16 March. The Government-in-exile of the Free State considered this act invalid and non-binding under international law and continued its activities.