Private equity investment funds have prevailed in coverage litigation involving a fashion company’s bankruptcy, with a Delaware court holding in a choice-of-law case they can seek restitution from their insurers under Delaware law in a case involving “ill-gotten gains” under their directors & officers and errors & omissions coverage.

New York-based Sycamore Partners and its affiliates acquired the Jones Group, a holding company that owned several retail fashion brands including Nine West, and allegedly raided its high-performing assets, leaving the remainder as an “overly leveraged shell,” according to Friday’s ruling by the Delaware Supreme Court in Sycamore Partners Management L.P. et al. v. Endurance American Insurance Co.

During bankruptcy proceedings, the company’s bankruptcy estate sued the investment funds and their managers for fraudulent conveyance, which is the illegal or unfair transfer of property to another party via a bankruptcy trustee, breach of fiduciary duty and related business torts.

The investment funds settled the claims for $120 million, then sought coverage from their insurers, Starr Indemnity & Liability Co., Markel American Insurance Co., Argonaut Insurance Co., Great American Insurance Co. and Ironshore Indemnity Co. The insurers, however,  however refused to pay, and the funds filed suit seeking coverage.

Among the defenses raised by the insurers was the “uninsurability” defense, with the insurers contending the funds’ settlement was “uninsurable as matter of public policy because it represents disgorgement of, or restitution for, ill-gotten gain,” the ruling said.

However, the laws of Delaware, where Sycamore is organized, and New York, where Sycamore is headquartered, differ as to whether insurers must pay, with New York law having a public policy against public restitution or disgorgement in these cases, and Delaware not having such a policy.

The policies involved had a provision that permitted disputes to be held in the jurisdiction “most favorable” to the policyholders. The insurers contended the provision is unenforceable “because it frustrates New York’s interest in preventing the indemnification of wrongful gains,” the ruling said.

The court, however, agreed that Delaware law should apply. “The insurers have not met their burden to demonstrate that the choice of law provision should not apply,” the ruling said.

“Accordingly, and because the funds validly have nominated Delaware as the jurisdiction ‘most favorable’ to them, Delaware public policy determines the uninsurability defense’s fate.”

Unlike New York, under Delaware law the settlement is insurable, the ruling said. “There is no such Delaware statute” that holds that restitution or disgorgement is uninsurable, the decision said, in granting Sycamore’s motion for partial judgment in the case.

Attorneys in the case did not respond to requests for comment.

Last week, a Delaware court ruled that Verizon Communications Inc. can recover $24 million in defense costs in connection with litigation surrounding a 2006 spinoff.