Should the tenant receive the deposit back?

Tenancy Deposits

I wonder if you could advise, we had a tenant on a 12 month tenancy agreement and they left one month prior to the end of that agreement. We discovered before they vacated the property that their deposit had not been insured and we insured it straight away whilst they were still tenants and sent out a copy of the certificate that day in the post. The tenants were fully aware of the rules of the TDS scheme as they informed us that they were going to apply for three times the amount back as it wasnt insured within the 14 day period. We entered into a dispute with TDS at the landlords request as he felt that the deposit should have been used to cover the last months rental arrears. We have just been informed by TDS that the tenant can receive the deposit back as we never stated in the tenancy that the deposit was held in a TDS scheme? Our tenancy does state that in the case of outstanding rental arrears then the deposit would be used to cover this. Can you please advise your thoughts on this case and can we go back to TDS and say that we would like for it to go to court?
Many thanks