The Petty-dwarves were Dwarves of several houses, which had been exiled for various reasons, such as small stature, bodily deformity or slothful disposition. They were the first to cross the Ered Luin in the First Age, and established strongholds in Beleriand before the Elves arrived, at Nargothrond and Amon Rûdh.
The Sindar, not acquainted with Dwarves yet, saw the Petty-dwarves as little more than bothersome animals, and hunted them. Not until the Dwarves of Belegost and Nogrod established contact with the Sindar did they realize what the Petty-dwarves were. Afterwards they were mostly left alone, but not before the Petty-dwarves came to hate all Elves with a passion.
Petty-dwarves were differed from normal Dwarves in various ways: they were smaller, far more unsociable, and they freely gave away their names: other Dwarves kept their Khuzdul names and language a secret. This may have been one of the reasons they were exiled.