Character.AI Bankruptcy Puts Disney Deal and Multistate Investigation in Focus

The Tech Justice Law Project and the Social Media Victims Law Center, which represented plaintiffs in many of the cases involving Character.AI, declined to comment.

Character.AI Continued Developing AI Tools Despite Financial Struggles

Despite losing key staff after the Google deal and struggling with profitability “constantly,” according to the current CEO, Character.AI continued developing artificial intelligence tools. Those projects included “real-time audio-driven FaceTime-style video generation with fictional characters,” the CEO said.

In August 2025, Character.AI worked with an investment banker to find a strategic buyer or investor. According to the company’s bankruptcy filing, Character.AI and its bankers received “consistent feedback” that the product and user base were “impressive,” but ongoing litigation and “excessive regulation” made the company unpurchasable.

46 States and Territories Investigated Character.AI

In November of that year, Character.AI learned that a coalition of state attorneys general had begun investigating the company. By the time Character.AI filed for bankruptcy, the multistate investigation had expanded to 46 states and territories.

According to the bankruptcy filing, the National Association of Attorneys General filed notifications of interest on behalf of 40 states. The investigations identified “serious issues” involving Character.AI, including screenshots of a chatbot allegedly encouraging minors to hide self-harm and kill their parents.

A Character.AI spokesperson said the filing “does not accurately portray the security of our platform.”

According to the filing, Character.AI was negotiating with states over how to address the issues they had identified. The company was unable to reach an agreement and declared bankruptcy.

Disney Could Acquire Character.AI Staff and Technology

If the deal is completed and approved by a court, Disney will gain much of Character.AI’s staff and technology stack while avoiding the ongoing legal issues that contributed to the company’s downfall, including the multistate investigation.

The states that filed bankruptcy notices of interest have been identified by the Oregon Department of Justice. They reserve the right to challenge the bankruptcy plan, potentially leading to a dispute over the final outcome of the proceedings.

“It’s bad for society when corporations exercise control without taking responsibility,” Newman said. “And that’s what it seems like.”

This story was originally published by WIRED.