I thought it just meant "It's not bad" but I read some comments from Japanese people who said that it can sound too condescending or like the speaker feels superior to the listener. Why is that? In what circumstances could this happen and when can it be used as a normal reply without sounding rude?
EDIT: after reading the replies, I guess it may be the は that makes it condescending?
I think it may sound condescending because it sounds like you have the right to say something is clearly bad. Typically, you can directly say 悪く(は)ない to someone when you judge their performance/creation as a teacher/expert/senior/etc. When the creator/performer is not present, 悪く(は)ない tends to be more often used. (For example it's usually safe to say あの映画は悪くなかった to your friend.)
And please note that this は is important. 悪くない is relatively positive as compared to 悪くはない. Sometimes it can mean "it's not bad" in the sense of "it's good if not perfect", depending on the context and the tone of your voice. 悪くはない has some negative implication. It means "it's at least not bad" in the sense of "it's still far from perfect." 悪くはない has clearly different connotation from "It's not bad", so please use it carefully.
「悪{わる}く(は)ない。」, contrary to what you seem to believe, does not really mean "It is not bad.". At least, that is not what the phrase means all the time.
"It is not bad." is only the dictionary or machine translation of 「悪{わる}く(は)ない。」. It fails to include the nuance of the Japanese phrase.
When native speakers such as myself say 「悪{わる}く(は)ない。」, they often imply that the object of the discussion is not too good. 「悪{わる}く(は)ない。」, in Japanese, would suggest that unstated negative connotation more often and/or strongly than the phrase "it is not bad." does in English.
This is why I, as an English-learner, was quite shocked some years ago when I found out that English-speakers seemed to often say "not bad" in situations where they clearly meant to say "pretty good". I am not saying that this usage of 「悪{わる}く(は)ない。」 never occurs in Japanese, but I can assure you that it is rarer in Japanese.
Thus, depending on the situation, the speaker, the intonation, the phrase 「悪{わる}く(は)ない。」 can sound condescending, negatively judgmental, etc. (That is called 「上から」 in colloquial Japanese.)
Thus, a safer phrase choice for Japanese-learners would be:
・「（なかなか）いいですね。」
・「いいと思{おも}います。」 , etc.
I think writing 悪く（は）ない makes it look as though the は is optional and doesn't change the meaning.
In fact, I would say
悪くはないよ ≒ It's not that bad!
悪くないね ≒ Not bad, is it? (= Pretty good, right?)
Although standard grammar is not the answer to all, note that は here would be the contrastive は, giving way to interpretations as "not as bad as you say / as I expected (but still pretty bad)" which is how it can be interpreted to be condescending.
I would also say that — just like in English — context is also important. If there is a doubt of whether something is bad or not, saying "Not bad" is more ambiguous than when something is clearly good...
If you say "not bad!" in English, it is usually considered as a word for compliment. But in Japan, it is usually not. The asker's statement "the phrase 「悪くはない」 sounds as speaker feels superior to the listener" is exactly hitting the spot of the common sense in Japan. It is commonly used in a critical manner with obfuscation.
The reason why "not bad" does not mean "good" in Japan is that "悪くはない(waruku-wa-nai)" is only a part of a common phrase; the full form of the phrase is "悪くはないが、良くもない(waruku-wa-naiga-yokumo-nai)" which means "it is not bad, but there is also nothing good."
When a Japanese person is told as "waruku-wa-nai (not bad)", the person will clearly remember the rest part of the phrase "... ga yokumo-nai( ... but there is also nothing good)" and understand that the mention comes in a response which is not appreciated.
Indeed, some Japanese people do not comprehend such obfuscation; such people are usually classified as "空気が読めない (ku:ki-ga-yomenai)" which means a guy who cannot read between the lines. This is also contracted and obfuscated by an intentionally wrong spelled word "空気嫁 (ku:ki-yome)" .
悪くはない: "Not bad, but could be better" (short translation, nuance included)
If you feel the condescension in the English version, that's more or less the same condescension in the Japanese version.
は, when put in the middle of a negative adjective like that, implies "...but it could be a whole bunch of other things". Technically speaking it could be a whole bunch of other things, but practically it means it could be a whole bunch of other things short of being its complete opposite.
Examples:
悪くない: simply "not bad"
悪くはない: "not bad, in the purest sense of the word, but it could be a whole bunch of other things like mediocre or subpar, and it could also mean 'not awesome', so don't get carried away."
寒くない: simply "not cold"
寒くはない: "not cold, in the purest sense of the word, but it's not necessarily 'turn the A/C on full blast' hot, either, so it wouldn't hurt to bring a sweater, even though you might not use it"
