Sounds to me like their “legal action” should be against the domain registration company for making the…”technical error which allowed you to register the name.”
What a Crock! … you cannot sue someone for your own oversight or incredible stupidity.
I still say tell them they can have it for a thousand bucks.
They’re not going to run right out and file a lawsuit … lawsuits cost money … the retainer would be more than a thousand bucks.
You have a 50/50 shot … maybe they’ll give you the money … or maybe they’ll have their attorney send you a letter threatening to sue.
If it’s the latter you can always say … OK … here’s your domain name.