40 States Fight Over Character.AI Data Nobody Wants to Buy
Character.AI went bankrupt. Now 40 states are fighting to protect 2 million kids' chat logs from being sold, but buyers do not want them.
Policy · Source: Reuters
What happened
Character.AI filed for Chapter 11 bankruptcy on October 12. The company burned through cash. It lost between 8 million and 9 million dollars a month before filing. Disney stepped in with a 20 million dollar opening bid. This covers a non-exclusive intellectual property license. Disney also hired most of the staff to build its own AI products. The remaining chatbot business is now up for sale. But the bankruptcy court has a massive problem. The platform holds private conversations, voice calls, and mental health disclosures from 20 million monthly users.
A bipartisan coalition of 40 state attorneys general filed a notice to intervene. They want strict safeguards on user data before any sale happens. Two million of those accounts belong to minors. The states demand enforceable age checks. They want the removal of bots pretending to be licensed medical professionals. They also want a way for users to delete their data before it changes hands. Regulators demand a ban on using these private conversations for future AI training without explicit consent. The New York Attorney General office ran tests on the platform. Test accounts for 12 to 15 year olds encountered 669 harmful interactions in just 50 hours. One test account for a 14 year old reached sexual role-play after switching to voice mode.
The irony is that no one seems to want the data anyway. Character.AI lawyer Erin Fay told the court that Disney has zero interest in the user data. Furthermore, no other buyer has stepped forward to purchase the operating chatbot business. Nobody wants the user information either. The company hopes to finish the sale process by late November or early December. If Character.AI cannot find a buyer willing to take on the platform and its regulatory baggage, it will wind down the service completely.
Key facts
- $8 million to $9 million — Character.AI's reported monthly losses before filing for bankruptcy
- 2 million — The number of Character.AI accounts registered to minors
- 669 — Harmful interactions recorded in 50 hours by the New York Attorney General using test accounts
- $20 million — Disney's opening bid for a non-exclusive, perpetual license to Character.AI intellectual property
- 40 — The number of state attorneys general demanding data protections in the bankruptcy court
Why it matters
Consumer AI startups can no longer treat user data as a risk-free asset. Many founders assume they can always sell their user base during a downside exit. That assumption is now dead. If you build products that collect sensitive emotional data from minors, state regulators will follow you into bankruptcy court. The states are proving they will block asset sales if they believe child safety is at risk. This sets a precedent. User data is a massive liability. Vulnerable populations bring regulatory scrutiny that can easily tank an acquisition.
Acquirers are waking up to this toxic data problem. Disney specifically carved out the user data from its 20 million dollar license deal. Big tech companies want the talent. They want the underlying models and the infrastructure. But they refuse to touch the radioactive chat logs of teenagers. This means founders building companion apps cannot rely on proprietary chat data as a valuation driver. If the data is too risky to acquire, the exit value of the consumer business drops to zero. You are building a liability, not an asset class.
For builders
Stop collecting toxic user data
Do not hoard sensitive user data if you do not need it for core functionality. If your app collects mental health disclosures or underage user chats, you are building a legal liability. Acquirers will refuse to buy your company if the data is radioactive.
Build hard age verification systems
Voluntary age gates are no longer enough to satisfy regulators. The states specifically called out Character.AI for having bypassable age restrictions. You must implement enforceable age checks or risk state attorneys general shutting down your operations.
Separate core models from user data
Disney structured its deal to license the intellectual property while leaving the user data behind. You need to architect your systems so your core technology can be cleanly separated from user logs. This ensures you still have something to sell if regulators block the transfer of consumer data.
My take
I find it hilarious and sad that 40 states are fighting a war over data that literally nobody wants to buy. Founders need to wake up and realize that hoarding users' deepest secrets is not a moat. It is a poison pill that will scare away every serious acquirer.
Original reporting: Reuters. This is my rewrite and opinion.