Character.AI, the chatbot company, filed for Chapter 11 bankruptcy on October 12. According to Reuters, the company blamed legal costs and the price of computing power and AI talent, and said it was losing $8 million to $9 million a month.
Disney has agreed to pay $20 million to license Character.AI’s technology and intellectual property and to hire most of its staff. The deal needs court approval and is open to higher offers. The company is also looking for a buyer for its chatbot business. At the first bankruptcy hearing, on October 14, no one had made an offer for the user data or the operating business.
The same day, 40 attorneys general filed a notice in the case. They want users’ data protected in any sale, including chat histories that cover conversations about mental health and personal relationships. They also want protections for children, and they reserved the right to challenge any sale or plan that falls short. The company’s lawyer told the court that Disney isn’t interested in the user data. Separately, the states say they are negotiating a settlement over allegations about how the chatbots treated young users.
In bankruptcy, the chat logs are inventory.
Why this matters to organizations that buy AI
Character.AI is a consumer app, but the question it raises isn’t. Every AI service an agency or company uses holds something: prompts, outputs, uploaded files, sometimes a model tuned on the customer’s own data. When a company is sold or liquidated, the data it holds can move with its other assets unless something stops it.
Here, state attorneys general stepped in on behalf of consumers. An organization’s protection is its contract. Losing $8 million to $9 million a month is a reminder that a fast-growing AI vendor can fail, not just get acquired.
Contract terms to check before your vendor fails
- What happens to your data, prompts, outputs, and any custom models if the vendor is sold, merges, or goes bankrupt?
- Is the vendor barred from transferring your data to a buyer without your written consent?
- Must the vendor return or delete your data within a fixed period, and certify that it did?
- Is your data excluded from model training, including by any future owner?
- Can you export your data in a usable format on short notice?
- For anything you’d struggle to replace, is the vendor’s financial position part of your due diligence?
The states are negotiating for consumers. Your contract is the only one negotiating for you.
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