Ex-Northern Ireland Secretary Peter Hain's decision to appoint two Orangemen to the Parades Commission has been ruled unlawful by the Law Lords.
Don MacKay (left) and David Burrows are prominent Orangemen
The House of Lords ruled that there was a conflict of interest in the 2005 appointments of Portadown Orangemen David Burrows and Don Mackay.
They said their presence on the body "would lead to the perception of bias against the nationalist community".
The judgement overturned a Court of Appeal decision made in June 2006.
The case was brought to court by Joe Duffy, a resident of the nationalist Garvaghy Road in Portadown, who sought to overturn the appointment of Mr Burrows and Mr MacKay.
Mr Mackay has since quit the commission after it emerged that he listed Democratic Unionist MP David Simpson and SDLP MLA Dolores Kelly as referees without seeking their permission.
The residents, who initially won their case in the High Court, complained that Mr Hain had written to the main political parties, the four main churches and the loyal marching orders during the appointments process, but had not sought applications from any residents' group.
In their majority decision, the appeal judges said Mr Hain had not been required to achieve a balance between individual members of the body.
Overturning that ruling on Wednesday, Lord Bingham said Mr Hain had made a mistake.
"I feel bound to conclude that the decision to appoint Mr Burrows and Mr Mackay was one which a reasonable secretary of state could not have made if properly directing himself in law," he added.
"No reasonable person, knowing of the two appointees' backgrounds and activities, could have supposed that either would bring an objective or impartial judgment to bear on problems raised by the parade in Portadown and similar parades elsewhere."
Speaking outside the court, Brendan MacCionnaith, spokesman for the Garvaghy Road Residents' Group, said they had always questioned the legality of the appointments.
"When this present commission was appointed, we stated that it was far from independent, that it was essentially 'a packed jury', and that it certainly would not enjoy the confidence of the nationalist community in Portadown," he said.
"Ever since the present Parades Commission took up office in January 2006, British government ministers, along with the commission's chair, Roger Poole, have publicly and robustly defended what have now been proven to be totally unlawful appointments."
The Grand Orange Lodge of Ireland said: "The legislation establishing the Parades Commission and the rules and regulations under which it operates are deeply flawed.
"We believe these appointments were an act of desperation by the then secretary of state as a final bid to try to make a failed system work.
"This latest decision calls into question the legal standing of determinations made by the Parades Commission. The sooner it disappears the better for everyone."
The Parades Commission was set up by the government in 1997 to make decisions on whether controversial parades should be restricted.