The court-supervised sale of bankrupt chatbot company Character.AI moved forward on Friday over objections from a coalition of 39 states and the District of Columbia, Reuters reported, while Bloomberg reported that the judge overseeing the case said a consumer privacy ombudsman is needed in connection with the Disney-led deal.
The hearing in Wilmington capped two weeks of escalating resistance to the sale procedures in Character Technologies' Chapter 11 case, which centers on a question with few precedents: what happens to the chat histories and personal data of roughly 12 million active and past users — including minors — when an AI companion platform goes up for sale. For more context on this story, see our ongoing AI trends.
The Disney Stalking-Horse Deal
Character Technologies filed for Chapter 11 in the US Bankruptcy Court for the District of Delaware on October 13, designating Disney Worldwide Services as the stalking-horse purchaser for what the filings call the Disney Target Assets. That deal, valued at $20 million, is a non-exclusive license to the company's code and patents plus certain claims — and, critically, it excludes the app, the brand, user data and chat histories. Disney has separately agreed to pay around $180 million to hire the majority of Character.AI's workforce.
Disney has told the court it has no access to the company's user data, is not buying personally identifiable information, and should not have its agreement reviewed by an ombudsman, according to the company's October 27 court reply as reported by PPC Land. But the sale motion also asks the court for authority to designate additional stalking-horse bidders for other assets, and the company has said it is marketing all of its assets, together or separately — with a wind-down of the platform possible if no buyer keeps it running.
39 States and DC Demand a Privacy Watchdog
The push for an ombudsman began with the US Trustee, the Justice Department office that oversees bankruptcy cases, which objected on October 27 and argued that a consumer privacy ombudsman is necessary before any sale of user information. On October 29, attorneys general for 39 states and the District of Columbia filed a joinder adopting that objection in full, according to PPC Land's review of the docket.
The states' filing pointed to the roughly 12 million active and past users of the platform, including minors, and noted that years of chat histories could contain sensitive information that would be difficult to separate from the rest of any data sale. The coalition also disclosed that the states have their own pending investigations of the company for consumer protection and privacy violations.
The legal mechanism turns on sections 332 and 363(b)(1) of the Bankruptcy Code: if a company's privacy policy bars transferring personally identifiable information to unaffiliated parties, such a sale can proceed only if it is consistent with that policy, or if the court first appoints a disinterested ombudsman — no later than seven days before the sale hearing — who can then inform the court about whether the sale would break the privacy promises made to users.
The states added a second, pointed claim: that Character.AI's sale motion did not make it "readily apparent" that, beyond the Disney license, the company was also seeking to sell its entire platform — a distinction that matters because a full platform sale would carry the accounts, chat histories and data that the Disney license expressly excludes.
What the Company Says
Character.AI's position, laid out in its October 27 reply, is two-layered: the company maintains that its privacy policy as of the bankruptcy filing permits the sale and transfer of user data in this case, meaning no ombudsman is legally required. But it also said it was willing to consent to one under appropriate circumstances, noting that its limited liquidity cannot support a substantially extended process, and that it was in talks with the US Trustee to resolve the issue before the hearing, PPC Land reported.
Separately, Recorded Future News reported that the Justice Department raised privacy concerns over the potential sale of Character.AI chats, underscoring that the data question has drawn federal as well as state attention.
What Happens Next
Friday's hearing leaves the case on a dual track. Reuters reported that the asset sale process moved ahead despite the states' objections, while Bloomberg reported that the judge indicated an ombudsman is needed — a combination that would let bidding proceed while an independent reviewer examines the data questions ahead of any final sale approval.
Whoever ends up with Character.AI's assets, the case is shaping up as the first major test of how AI companion data is treated in bankruptcy. Chatbot archives occupy ambiguous territory: they are not financial records or medical files, but they can contain confessions, intimate conversations and, in the case of a platform whose user base includes children, material that states argue deserves heightened protection.
The court's docket in In re Character Technologies, case No. 26-11603, shows the sale process advancing on a compressed timeline. Whether the ombudsman process satisfyingly answers the states' concerns — or merely documents them — will influence how the next AI bankruptcy is negotiated.
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