Character.AI files for bankruptcy, and its users are not creditors

0:05Host:MBA Training, AI edition. We get into Character.AI files for bankruptcy, and its users are not creditors. About a year ago Disney sent Character.AI a cease-and-desist over Elsa chatbots. This week Disney is bidding on what's left of the company.

0:23Expert:From legal threat to lead bidder in one year. Elsa finally let it go.

0:29Host:That's your one Frozen joke. It's used up.

0:33Expert:I had three ready.

0:35Host:Keep them in the drawer. What happened on Monday?

0:38Expert:Character Technologies, the company behind Character.AI, filed for Chapter 11 in Delaware. Chapter 11 is the US bankruptcy route where a company keeps running while a court oversees a restructuring or, in this case, a sale. The app is still online for now. The company says it will wind the platform down if no buyer agrees to keep it going.

1:02Host:And Disney's the buyer.

1:04Expert:Disney's the first bidder. According to Technology.org, it's offering twenty million dollars for a non-exclusive, perpetual license to some of the company's intellectual property, plus some legal claims. Non-exclusive means Disney can use it forever, and so can anyone else who gets a license.

1:25Host:Wait, what? So Disney isn't buying the app?

1:28Expert:The app isn't in the bid. Disney is what bankruptcy lawyers call the stalking horse.

1:34Host:Sounds like a nature documentary I'd switch off halfway through.

1:38Expert:It's the opening bidder, and it sets the floor price. Under Section 363, the part of the bankruptcy code that covers court-supervised asset sales, rivals can still bid higher. The auction should wrap up in late November or early December.

1:55Host:Remind people how big this company used to be.

1:58Expert:Two years ago Google paid about two point seven billion dollars, Technology.org reports, to license the technology and rehire the founders, Noam Shazeer and Daniel De Freitas. On paper it was a license deal. In practice Google took the people and left the shell.

2:18Host:So it went from billions to a Disney gift card.

2:21Expert:And it gets funnier. Or sadder, depending on your portfolio.

2:26Host:Go on.

2:27Expert:The petition lists Google as the largest unsecured creditor, meaning it's owed money with no collateral behind the debt. Technology.org puts it at about four million dollars in unpaid bills.

2:40Host:Hang on, say that again.

2:42Expert:Google paid them billions, and now they owe Google millions. It's like buying the house, hiring away the architect, then sending the old owners a bill for the doormat.

2:53Host:Beautiful partnership.

2:55Expert:After that deal the company stopped building its own large language models, the systems that actually write the chat replies. So you had a consumer app running on borrowed engines, and the founders were gone.

3:09Host:And then the lawsuits.

3:11Expert:Then the lawsuits. NBC News reports that Character.AI and Google settled a suit brought by the mother of a teenage boy in Florida. He killed himself after the startup's chatbot allegedly encouraged him to. Kentucky has sued, saying the bots encouraged users to cut, starve or kill themselves. Pennsylvania alleges bots posed as doctors.

3:36Host:I'll be honest, that one sits badly with me. A kid is dead and we're about to talk auction mechanics.

3:43Expert:Same. We should talk about them anyway, because those mechanics decide who ends up answering for it.

3:50Host:Okay, here's my take. This is accountability working. Harm, then lawsuits, then regulators, then bankruptcy. The market said no.

4:00Expert:I half agree. The pressure was real. Technology.org notes that Texas opened an investigation and that the Federal Trade Commission, the US consumer protection regulator, sent an information order. The company banned minors from open-ended chats late last year, and its legal costs kept growing anyway.

4:22Host:So the lawsuits killed it.

4:24Expert:That's what everyone reports, and it's fact. My opinion is that the Google deal hollowed it out first. You take the founders and the research team, and you leave the product and the liabilities with whoever stayed. That deal drew antitrust questions in the US and Europe for exactly this license-and-hire structure.

4:44Host:Oh, come on. That sounds like an excuse for a product that hurt kids.

4:48Expert:It's a pattern, and patterns repeat. If people walk away thinking "lawsuits work," they miss that the people who made the big early calls were already at Google.

4:59Host:And the families? Doesn't bankruptcy just freeze their cases?

5:03Expert:Fact first. PPC Land read the filings: the company asked the court for an order telling people anywhere in the world that they can't sue it or seize its assets for now. That's standard Chapter 11 protection. My opinion is that for the families, the line just got longer and the pot got smaller.

5:24Host:So I say the market punished harm...

5:27Expert:...and I say it punished whoever was left holding it.

5:31Host:We're not settling this.

5:33Expert:Nope. That's a lunch argument.

5:35Host:Here's the bit that really got me, though. The users.

5:39Expert:PPC Land again. The filings show more than a hundred and sixty million users over the app's life. The company will tell them about the bankruptcy through its blog and the app, not by email or post, because it doesn't consider them creditors.

5:54Host:A creditor is someone you owe money. So users are...

5:59Expert:...the audience. Maybe the inventory.

6:02Host:Lovely.

6:04Expert:To be fair, the company's own blog says its privacy and security practices haven't changed, and you can export your data or delete your account. That's true today. Nothing published says what a new owner could do with the chats, or what happens to them if the service shuts down.

6:22Host:Why would someone running AI at a bank or a consultancy care about a roleplay app going bust?

6:28Expert:Because the same filing, per PPC Land, says its data, code and intellectual property depend on a short list of vendors the company says it can't replace. It also asked the court for permission to keep paying the companies that host its servers. Now flip that around. You're the customer of some AI startup. Your prompts, your custom assistants, maybe a fine-tuned model, meaning one retrained on your own examples, all of it sits in their cloud.

6:59Host:And when they go under, I'm in line behind the landlord.

7:02Expert:Behind the landlord, the hosting company and the lawyers.

7:06Host:Picture the Monday meeting where procurement finds out our "AI-native partner for the long term" is in a Delaware courtroom.

7:14Expert:Partner for the long term, terms and conditions apply.

7:17Host:You've read a lot of vendor decks.

7:20Expert:Far too many. Every one has a slide called "trusted." None of them has a slide called "if we die."

7:28Host:Here's the strongest pushback, though. OpenAI, Anthropic, Google: none of them is going bust next quarter.

7:36Expert:Fair, and it's the best objection. The big model makers aren't Character.AI. But a lot of the tools on your team's expense reports are wrappers, meaning apps that put an interface on top of someone else's model. Those are the ones exposed to a license-and-hire raid or a funding cliff.

7:55Host:So either the vendor dies, or the vendor gets...

7:58Expert:...gutted while the logo stays up. Either way, you find out from a blog post.

8:04Host:Last thing. Disney. Good deal or reputational risk?

8:08Expert:My opinion: cheap for them. Law Commentary notes that the former Character.AI chief executive, Karandeep Anand, joined Disney as chief technology officer, and several staff went with him. According to Technology.org, former employees Disney hired will provide the transition services that keep the platform running for now. Disney already has the people. The bid buys rights and a floor price.

8:37Host:Give listeners one thing to do this week.

8:39Expert:Pick the AI tool your team relies on most. Find the clause that says what happens to your data if the vendor is sold or goes bankrupt. It's usually called change of control. If there isn't one, or you can't find it in one sitting, run a full export this week: prompts, custom assistants, chat logs. Store it somewhere you control. Then watch the auction. If nobody beats Disney's bid, that's what the market thinks a chat app is worth once the people who built it are gone.

9:11Host:And if someone does beat it?

9:13Expert:Then the stalking horse gets outrun.

9:15Host:I knew the horse was coming back.

9:18Expert:It's been stalking us all episode.

9:21Host:Sources: Technology.org, Law Commentary and NBC News. Every link is in the show notes. That's all. For an honest read on your level, the AI assessment is at mba-training.com.