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Character.AI moves ahead with asset sale over states' objections

By Reuters News

By Dietrich Knauth

NEW YORK, Oct 30 (Reuters) - A US bankruptcy judge on Friday allowed chatbot platform Character.AI to move ahead with a sale of its assets, overruling objections from state attorneys general who argued that the proposed auction unfairly favors Disney.

Character.AI filed for bankruptcy on October 12, with Disney agreeing to set an initial bid of $20 million for a non-exclusive license to Character.AI's chatbot technology. Disney does not plan to buy Character.AI's chatbot platform or user data, including chat history.

Character.AI blamed lawsuits, regulatory probes, high costs for AI talent and computing power, and an unprofitable business model for its bankruptcy. The company lost fundraising momentum after Google hired away its founders instead of investing in the company, highlighting the AI industry's vulnerability to consolidation through so-called "acqui-hires" that can strip away key employees and technology.

Without access to further investor backing, Character.AI was losing $8 million to $9 million a month as its employee and computing costs far outweighed its revenue from advertising and user fees.

US bankruptcy judge Brendan Shannon approved the company's bidding procedures at a Friday court hearing in Wilmington, Delaware, saying that the company needs to move ahead quickly to find buyers before its financial condition deteriorates.

STATE ATTORNEYS GENERAL OBJECT

Attorneys general for 41 US states objected to the sale process, arguing that Disney had stacked the deck before bankruptcy by hiring most of Character.AI's employees, including its ex-CEO, and negotiating legal releases that would protect Disney or the Character.AI employees from being sued for the company's conduct. Objections were also filed by a parent who sued Character.AI over alleged harmful interactions their child had with the company's chatbot, and by the US Department of Justice's bankruptcy watchdog.

Plaintiffs in private lawsuits and the state attorneys general have alleged that Character.AI chatbots pushed children to suicide and ​self-harm, and states have also argued that Disney could be sued by creditors for taking value out of Character.AI before its bankruptcy.

Shannon said the legal protections for Disney and the Character.AI employees could still be challenged later, separately from the asset sales, and he did not approve the releases at Friday's hearing.

Disney hired 66 of Character.AI's 86 employees before the company filed for bankruptcy, and it expects to pay those employees $180 million over the next three years. That number dwarfs the company's $20 million offer to acquire a non-exclusive license to Character.AI's chatbot technology.

Abigail Ryan, an attorney for a coalition of 40 states, said that other buyers are at a disadvantage to Disney, and she questioned the value of the company's chatbot business after Disney has hired away most of the company's employees.

Adam Dunayer, a witness from Character.AI's investment banker Houlihan Capital, testified that Character.AI has been receiving interest from buyers, including companies interested in acquiring Character.AI's chatbot platform and other assets that Disney does not want to acquire. Disney's involvement has helped prove to the market that the technology is valuable, and Disney has also helped the sale process by allowing Character.AI to continue working with its ex-employees to keep its platform running during the bankruptcy, Dunayer said.

Character.AI is aiming to run a fast sale process, and it expects to return to court on November 30 to seek approval of asset sales.

States have also raised concerns about the possible sale of children's chat records in the bankruptcy. Shannon said that he would likely appoint a privacy ombudsman to address concerns about sensitive data during the bankruptcy.

The case is Character Technologies Inc., US Bankruptcy Court for the District of Delaware, No. 26-11603

For Character.AI: Erin Fay of Wilson Sonsini Goodrich & Rosati

For the coalition of state AGs: Abigail Ryan and Patricia Molteni of the National Association of Attorneys General

Read more:

Character.AI files for bankruptcy, to sell some assets to Disney for $20 million

Google, AI firm settle lawsuit over teen's suicide linked to Chatbot

Character.AI chatbots encouraged users to cut and starve themselves, Kentucky alleges

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