The Equality Commission has said Newry and Mourne District Council gave little consideration to the impact on unionists of naming a play park after an IRA man.
The border local authority failed to comply with its own equality scheme when deciding to retain the controversial Raymond McCreesh Park name in 2012, the commission said.
McCreesh died on hunger strike in prison in 1981. A report into the 1976 Kingsmills massacre has linked him to the IRA murders of 10 Protestant workmen.
The commission said: "Our investigation has found that little consideration appears to have been given by the council to the impact its decision in this instance might have on the Protestant/Unionist community or to the damage it might cause to good relations."
The playground was first named after McCreesh in 2001, when an equality scheme did not exist and on the basis of a very limited survey.
Councillors voted to retain the name in December 2012, when one had been adopted, following a lengthy process. Twenty nationalist representatives voted to uphold the original name.
The commission found that the council breached its commitment in its equality scheme to have due regard to the need to promote equality of opportunity and to the desirability of encouraging good relations.
The commission's investigation said the council was "more focused on process and on maintaining the name of the play park than on paying due regard to the need to promote equality of opportunity and regard to the desirability of promoting good relations.
"There is little evidence that the duty was exercised in substance, with rigour and with an open mind in the decision-making process."
The commission made three recommendations, including that the council transparently review its decision to name the park after McCreesh, taking proper account of its legal obligations.
It also said the authority should review its wider policy on naming council facilities and complete both investigations and report back to it within a year.
McCreesh was not convicted of involvement in the Kingsmill killings but the Historical Enquiries Team of detectives said he was arrested on another IRA operation and caught in possession of one of the guns used at Kingsmill.
Ten textile workers were shot dead by the side of a road near the Co Armagh village after a gang of masked gunmen flagged down the minibus they were travelling home from work in.
The killers asked all the occupants of the vehicle what religion they were.
The only Catholic worker was ordered away from the scene and the 11 remaining workmates were then gunned down. Only one survived, despite being shot 18 times.
McCreesh, from the village of Camlough outside Newry, died in the Maze prison in May 1981. He was arrested five years earlier during a failed IRA ambush on an army patrol in south Armagh in 1976.
His convictions included attempted murder, conspiracy to murder, possession of firearms with intent to endanger life and IRA membership.
SDLP leader Alasdair McDonnell has expressed his regret about the hurt his party caused by voting for a children's playground to be named after a convicted IRA terrorist.