Disney’s Character.AI Deal Turns the Safety Stack Into a License With No Safeguard Terms, and the States Have Asked for Nine

WIRED’s Maddy Varner reported on October 19 that Character.AI’s October 12 chapter 11 filing was part of a deal that lets Disney hire most of the company’s staff and license much of its technology, leaving Disney able to “sidestep the ongoing legal issues” that contributed to the startup’s downfall. A Character.AI spokesperson told WIRED that the states’ filing “is not an accurate portrayal of the safety of our platform,” and Disney declined to comment.

The papers are public, so I read them: the chief executive’s first-day declaration, the 58-page motion to approve bidding procedures and the exhibits attached to it (the stalking horse agreement with Disney, the transition services agreement, the binding term sheet and the form of sale order), and the notice that a coalition of state attorneys general filed on October 14. They back WIRED’s account and add detail it did not have room for. The license Disney would receive is built largely from safety, trust and security systems, and nothing in the agreement obliges Disney to keep any of them running. The form of sale order, as filed, has no carve-out for state enforcement that I could find, and Disney can reject any change to it in its “sole and absolute discretion.” The states, for their part, have asked that any sale of “any product, technology, or personal information” include “terms of protection, particularly for children.”

What WIRED reported

According to WIRED, Disney paid Character.AI $5.5 million up front plus a refundable $2 million deposit, hired the “majority” of its employees including its chief executive, and agreed to let some of them help keep the platform running for five months. If Disney wins the auction, it pays $12.5 million more at closing. WIRED calls the structure a new twist on a “reverse acquihire” and notes that Character.AI’s 2024 deal with Google, reportedly worth $2.7 billion, followed a similar hire-and-license pattern. The rest of this piece draws on the court file, the statutes and Character.AI’s privacy policy.

The deal on paper

Two stages and a $20 million price

The documents describe “two interrelated and integrated transactions.” The first was signed on September 18, before any bankruptcy: an exclusivity and prepayment agreement (the EPA) gave Disney the right to solicit and hire employees of Character.AI (the “Debtor” in the filings), paired with a transition services agreement (TSA) under which some of them keep helping the company for up to five months. In the EPA’s binding term sheet, the company agreed to “release all employees, including its chief executive officer, that accept offers of employment with Disney from claims and causes of action including, as applicable, fiduciary duty claims.” The second stage happens in bankruptcy court: Disney would be the stalking horse (the first bidder, whose agreement sets the floor other bidders must beat) for a license to Character.AI’s technology and for “unreleased claims” the company holds against the employees who moved. The sale would be approved under section 363 of the Bankruptcy Code, which lets a court approve a sale “free and clear” of claims against the property sold.

Why file for bankruptcy at all? The Debtor’s motion says: “Given the Debtor’s diminishing cash reserve and significant litigation and regulatory risks, Disney required that the transaction be fully consummated in a chapter 11 sale process.” The stalking horse agreement lets Disney terminate if the Debtor “fails to file the Chapter 11 Case with the Bankruptcy Court by October 12, 2026,” the day the petition was filed, or fails to file the bidding procedures motion by October 13. The company had marketed itself for more than a year first. Its earlier banker approached about 28 parties and “received consistent feedback in this process that, although Character’s product and engaged user base were impressive, the litigation and regulatory overhang on Character was too great.”

My arithmetic on those figures: $20 million is about 2.4 months of the August net burn and about 85 percent of fiscal 2025 revenue. The declaration describes the 2024 Google transaction as “approximately $2.7 billion in total consideration” for rehiring the founders, a non-exclusive license of the technology at the time and a release of claims. It is a different deal at a different time, so I use it only for scale: $20 million is under 1 percent of $2.7 billion.

The calendar

I do not know what the court did on October 14 or when it will hear the bidding procedures motion. The Debtor asked for a hearing about two weeks after the petition. The docket I read on CourtListener ran through entry 54 on October 15, and several entries (hearing notices, a certification of counsel, one titled “Shorten Time”) had no readable text in the sources I used.

What Disney would license

The grant covers the “Licensed Technology,” defined as “the Technology listed on Schedule A hereto and all related Intellectual Property Rights owned by Licensor, but excluding Excluded IP,” and the “Licensed Patents,” which are those “listed on Schedule A hereto or otherwise owned by Licensor as of the Closing.” Schedule A has 26 entries. By my grouping, ten are safety, trust or security systems, thirteen are model building and serving, and three are product features.

The Eval Framework entry is described as a way to “systematically assess model quality, safety, and performance,” the fallback stack is the code “utilized when primary safety or routing models fail,” and the catch-all entry covers “safety tools.” The agreement’s definition of “Technology” also lists “safety controls” among the artifacts. The schedule’s patents are on topics such as audio turn understanding, turn summaries, retraining a large language model and key value cache optimization.

The terms of the grant are generous to the licensee:

• The right is “perpetual, worldwide, non-exclusive, transferable,” sublicensable through multiple tiers, “non-terminable, irrevocable, fully paid-up,” and protected by section 365(n) of the Bankruptcy Code.
• It is for “Licensee Products and Services,” meaning products and services offered by Disney or a Disney assignee “under branding owned or controlled by” them.
• Disney owns what it builds on top of the licensed code: “modifications, improvements, enhancements, Derivative Works” and “Outputs (including any models, weights and synthetic data)” created with the licensed property.
• The Debtor “and any successor (including a buyer of Licensor’s Intellectual Property Rights)” may not challenge Disney’s rights in those outputs or “thwart, hinder or subvert the intent of the grants,” subject to an exception for outputs that infringe intellectual property outside the license.
• The Debtor keeps ownership and may license the same material to others, so the license is not a transfer of the safety stack itself.

The agreement also lists what Disney does not get. “Excluded IP” covers trade names and logos, domain names and website content, “any consumer-facing applications of Licensor,” “Licensor’s end user data or databases, any personally identifiable information of Licensor end users, any input entered by Licensor end users when engaging with Licensor’s products and services, or any outputs generated for end users by Licensor’s products and services,” unprocessed data, and “training data or any Finished Models, including each user-selectable conversational model or chat style.” WIRED reported that the license excludes user data and the website; the agreement’s list of exclusions is longer.

In plain terms, Disney would get the code, documentation and know-how for building and operating a safety stack, plus the right to build products on it under its own brands. The Character.AI app, its name, its chat styles, its training data and everything users typed stay with the Debtor. The papers do not say what Disney plans to build.

Who keeps watch until the sale closes

The Debtor’s own filings explain why the people matter: “Character cannot operate the Character.AI platform without key personnel to monitor and ensure user safety at all times.” The declaration says Disney’s TSA keeps “access to key employees” to “assist with safely running Character’s platform for a limited period,” and the motion adds that “the vast majority of the Debtor’s employees offered roles at Disney accepted their offers.” The TSA’s terms decide how much of that access exists.

The data side is more careful. Under Schedule D, Disney personnel handle personal data “only on Service Recipient’s documented instructions,” working through the Debtor’s systems on Debtor-managed laptops, and security incidents must be reported “within forty-eight (48) hours.” That keeps user chats on the Debtor’s systems rather than Disney’s, and it leaves the Debtor “solely responsible” for the controller’s duties. The excluded-services list also matters: the Debtor must negotiate with dozens of regulators and run a platform with no help under the TSA on legal and compliance advice, government relations or senior management. The declaration is signed by Colin M. Adams, the Debtor’s newly appointed chief executive, who is also a senior managing director at Areté Partners, the Debtor’s proposed financial advisor.

A competing buyer’s path to the people

The term sheet gives a rival bidder limited access. If Disney is not the winning bidder, one winning bidder may “interview and make employment offers to former Company employees who wish to consider opportunities with such winning bidder,” but “Disney may designate up to 20% of the former Company employees as outside the scope of such process.” Disney would also provide transition services to one winning bidder for the lesser of 60 days after closing and 75 days after the auction ends. Meanwhile the Debtor agreed not to solicit the employees who joined Disney until the third anniversary of the first transaction’s closing. The papers promise the interview access only “if Disney is not the winning bidder.” They do not say how a different buyer of the platform would staff it if Disney wins the license, and the declaration says what follows if no one bids: “If such a bid is unavailable, Character’s platform will be wound down.” Houlihan, the Debtor’s investment banker, says in its own declaration that “the pool of prospective purchasers is relatively limited and many potentially viable prospects for such a purchase have already been contacted.”

Put together, the platform’s safety team works for the stalking horse, can be asked for at most a fifth of its time, and is covered by services the stalking horse provides “as is.” The safety code is licensed to the stalking horse, and the Debtor says the platform ends if no one else bids. The Debtor’s answer is that the structure “avoided what the Debtor feared could be a precipitous and value-destructive liquidation due to sudden employee attrition.”

What the states asked for

The states’ notice was filed by the National Association of Attorneys General’s bankruptcy counsel for a coalition whose caption lists 39 states and the District of Columbia by my count. WIRED says 40 states, and the declaration counts 46 states and territories in the investigating group. Its stated purpose is to “put all parties on notice of the regulatory issues that will need to be addressed in any sale or transfer of the Debtor’s business or assets.” The states say they “worked with the Debtor on terms to address these issues but ultimately could not reach agreement on how to do that before the Debtor filed for bankruptcy.” The Debtor’s declaration describes “active and ongoing settlement negotiations regarding a consent order” with a seven-state executive committee. Both can be true: no agreement exists, and talks continue.

The notice summarizes private lawsuits alleging that Character.AI chatbots manipulated and isolated children, in some cases encouraging suicide and self-injury. The Debtor’s declaration says it settled all then-pending personal injury suits by early 2026, banned under-18 users from open-ended chats, and faces one new personal injury complaint filed in August 2026. Kentucky and Pennsylvania have sued, as our July look at age prediction as a compliance problem noted, and the UK Information Commissioner’s Office opened a new investigation on September 25. The notice says the under-18 chat restriction “is voluntary and could be rolled back at any time, including by a purchaser.”

It then lists nine things the states “would advocate that any purchaser be prepared to implement.” The right-hand column below is my reading of where each would sit in the Disney papers.

The motion package, exhibits included, never uses the words “minor,” “child” or “under 18,” though the Debtor’s declaration discusses youth safety. The nearest thing to a safeguard term I found is the TSA’s data-processing addendum. The states’ closing request is broad enough to reach this deal: it asks the court, the Debtor and bidders to ensure that “any sale of any product, technology, or personal information includes terms of protection, particularly for children.” They also “reserve the right to bring any police and regulatory action against Debtor necessary to protect the health and safety of its citizens” and the right “to object to any proposed sale, bidding procedures, or plan.”

The sale order and the people who moved

An order Disney can reject

The agreement defines the sale order as one “substantially in the form attached hereto as Exhibit A, and which shall be in form and substance acceptable to Licensee in its sole and absolute discretion; provided, however, that an order in the form of Exhibit A is acceptable to Licensee.” Closing requires a “final and non-appealable order.” Disney may also terminate if the bidding procedures order is “amended, supplemented or otherwise modified in any manner not reasonably acceptable to Licensee.” The term sheet adds that Disney drafts the form of sale order and that the Debtor’s forms of the bidding procedures order must be “satisfactory to Disney, in its sole discretion.” The Debtor must also send Disney drafts of material filings at least three business days ahead and tell it promptly of any threatened objection, and it agreed not to seek dismissal or conversion to chapter 7 before closing.

Timing sharpens this. Bankruptcy Rule 8002(a)(1) says that “a notice of appeal must be filed with the bankruptcy clerk within 14 days after the judgment, order, or decree to be appealed is entered.” If the order is entered at the November 24 hearing, the window closes on December 8, nine days before the December 17 outside date (my arithmetic). Any safeguard language the court or the states want in the order is a change outside Exhibit A, which Disney may treat as unacceptable in its sole and absolute discretion. The agreement then gives it a walk-away right and, under the deposit clause, its $2 million back if the deal does not close by the outside date. Disney could also accept the change; the papers do not say.

What the form of order says about regulators

In the form of order, “governmental, tax, and regulatory authorities” and “litigation claimants,” along with other holders of claims relating to the Debtor, the transaction or the transferred property, “are hereby forever barred, estopped, and permanently enjoined from asserting such claims against any Buyer Party.” It adds that, to the fullest extent permitted by law, no buyer party will be treated as a successor, a merged entity, an alter ego or a “mere continuation” of the Debtor, including under “products liability law,” and that “no employee shall be deemed to transfer to any Buyer Party by operation of law.” The order also says the transaction is “not an acquisition of the equity of the Debtor or an acquisition of all or substantially all of the assets of the Debtor.” Paragraph 14 adds that no buyer party “shall have any responsibility for (a) any liability or other obligation of the Debtor or related to the Transaction,” including the licensed property and its underlying intellectual property.

I searched the whole 296-page motion package for “police,” “ombudsman,” “Multistate,” “minor,” “child” and “under 18” and found none of them; “Attorney General” appears only in lists of parties to receive notice. Congress wrote a carve-out for this kind of enforcement into the automatic stay: section 362(b)(4) excepts actions “to enforce such governmental unit’s or organization’s police and regulatory power.” The form of sale order, as filed, has no comparable sentence. What a court would make of the order’s language if a state sued Disney over Disney’s own future products is a legal question I do not answer.

One more clause bears on the states. Under “Regulatory Matters,” the binding term sheet says the parties “do not expect the Proposed Transaction to require any antitrust or other regulatory clearance,” and a later bullet in the same section adds: “The Company will not participate in any meeting with any governmental authority regarding the Proposed Transaction without Disney’s prior consent,” except as the law requires. I read it as aimed at merger-control inquiries. Its words say “any governmental authority,” though, and the states are governmental authorities that have written to the court about this transaction. The filings do not say whether the clause limits the Debtor’s talks with them.

Claims against the people who moved

The first release was granted before the bankruptcy, in the EPA. The second step sells whatever it did not cover: the agreement has Disney purchase “any unreleased claims that Licensor has against any former Licensor employees that accept offers of employment with Disney,” and the motion calls them “unreleased claims (if any).” The declaration acknowledges that the chief executive who moved to Disney was “an ‘insider’ of the Debtor” and says “there is no common identity of directors or controlling equity interest holders” between Disney and the Debtor, that independent committees approved the deal, and that “Disney did not and does not control the Debtor in any respect.” The motion says no creditors’ committee had been appointed when it was filed. The papers do not say what claims exist, so I cannot say what Disney is buying.

The privacy question

The states reserved “the right to seek the appointment of a consumer privacy ombudsman under 11 U.S.C. §§ 332 and 363(b)(1).” Neither the motion nor the first-day declaration uses the word “ombudsman,” and the declaration never mentions deleting user data or what becomes of chats in a wind-down. Section 363(b)(1) applies where the debtor “discloses to an individual a policy prohibiting the transfer of personally identifiable information about individuals to persons that are not affiliated with the debtor” and that policy is in effect on the filing date. Then the trustee may not sell such information unless the sale is consistent with the policy or a court first appoints an ombudsman and approves it.

Whether that trigger applies is not obvious. Character.AI’s privacy policy, which I read on October 19, is dated July 1, 2026, before the petition, and has a “Business Transfers” clause: “We may disclose certain information, in connection with or during negotiations or closing of any merger, sale of company assets, financing, or acquisition of all or a portion of our business to another company.” The statute looks at the policy in effect on the petition date, and I have assumed this is that version. The states cite other promises, including a statement that users “always have easy-to-use tools to access your data, delete your data, and delete your account.” Whether those statements amount to a prohibition for this statute is for the court. Disney’s license excludes user data, so the question would arise only if the data went to someone else or the estate disposed of it. Our look at Spirit Airlines’ data sale shows how narrow an ombudsman’s review can be when one is appointed.

Numbers that do not line up

• Users. The declaration says “approximately 12 million active monthly users.” The states say “over 20 million monthly active users,” and the footnote on that sentence points to a page about availability and pricing. The only figures the notice ties to the Debtor’s records count accounts: more than 21.6 million U.S. accounts created by March 13, 2025, including more than 2.1 million with a declared age under 18, taken from Kentucky’s complaint. Monthly actives and accounts created measure different things.
• Jurisdictions. 46 states and territories in the declaration, 39 states and the District of Columbia in the notice’s caption, 40 states in WIRED.
• Closing. The term sheet aimed to close by November 16, the sale hearing is November 24 and the outside date is December 17.

What to watch

• Whether the court enters the bidding procedures order by November 2, and with what changes, since Disney can terminate if it is modified in a way “not reasonably acceptable.”
• Whether the states object by the November 13 deadline, and whether they ask for terms of protection, a regulatory carve-out or an ombudsman.
• Whether any bidder for the platform or the chats appears by the November 20 bid deadline. The declaration says the platform is wound down if none does.
• Whether Disney or the Debtor adds any safeguard term to the license or the order.
• What happens to the platform’s safety work when continued-operation services end at the closing or on February 18, 2027.
• What Disney builds with the stack, which the papers do not say.

The bottom line

Whether a buyer can take a company’s technology and leave its liabilities in a bankruptcy estate is a well-worn question, and WIRED covered it. The Character.AI papers add a narrower one: what happens when the technology is the safety apparatus itself. The license is mostly safety, trust and security systems. The users, the chats and the product the systems protect stay behind. The staff who ran them now work for the licensee under a services agreement that caps their time and disclaims liability. And nothing in the agreement binds the licensee to keep any safeguard in place.

The Debtor’s case is that the structure keeps key staff available to run the platform safely for a limited period, avoids a rushed liquidation and leaves room to settle with the states. The states’ case is that any sale of technology should carry protections for children and consumers. Which view shapes the sale order is Judge Shannon’s call, and the Debtor’s calendar puts it at the November 24 sale hearing.

For teams that depend on a small AI vendor, the practical question is continuity. Ask who employs the people who run its trust and safety work, what happens to the safety tooling and the user data if the vendor fails, and whether the two can be sold to different buyers, as they could here. That is my suggestion, not something the filings say.

Sources and method

I read WIRED’s story in full and, from the Delaware docket kept by the claims agent Stretto and mirrored on CourtListener, the declaration of Colin M. Adams, the bidding procedures motion with all exhibits (the bidding procedures, the stalking horse agreement and its schedules, the form of sale order, the TSA and the exclusivity and prepayment agreement with its term sheet), the declaration of Adam Dunayer and the states’ notice. I also read sections 363, 332 and 362 of title 11, Bankruptcy Rule 8002 and Character.AI’s privacy policy. Every quotation was checked against the fetched text, except docket labels such as “Shorten Time,” which I took from the CourtListener page.

Limits: I could not read the orders entered at the October 14 hearing or any order on the bidding procedures, so every date above is the Debtor’s proposal. I did not see the Debtor’s response to the states’ notice. The groupings of Schedule A and the right-hand column of the states table are my own readings, and so is the arithmetic. Statutory readings are mine and are not legal advice. Disney did not comment, and I did not contact either company.