US states seek children's data protections in Character.AI bankruptcy

Oct 14 : A group of 40 state attorneys general on Wednesday urged a US bankruptcy judge in Delaware to protect young users of Character.AI and keep their data safe during the AI companion company's bankruptcy.

Character.AI filed for bankruptcy late on Monday and is seeking to use its Chapter 11 case to resolve the states' investigations and lawsuits, license its technology to Disney for $20 million, and seek a buyer willing to take on its chatbot business. 

Abigail Ryan, an attorney for the states, told US Bankruptcy Judge Brendan Shannon in Wilmington that the states are negotiating a settlement with Character.AI over allegations that its chatbots impersonated licensed medical professionals and exposed children to sexualized and abusive interactions.

Even so, Ryan said, the states want to make sure that any buyer of Character.AI's assets will protect users' chat histories and improve safety features.

"We're willing to work with the buyers to find safeguards, but we don't want to see what has transpired in the past start over with a new purchaser," Ryan said at the company's first hearing in US bankruptcy court.

"This company has collected some of the most private thoughts children have ever shared, and now those conversations could be sold off to the highest bidder," New York Attorney General Letitia James, a Democrat, said in a Wednesday statement issued just before the court hearing.  

NO OFFER YET

Character.AI's attorney, Erin Fay, said she heard those concerns "loud and clear," but said that no buyer has yet made an offer for the company's user data or its operating chatbot business.

The company's platform allows users to interact with and create generative AI characters customized by user prompts and often modeled on fictional characters, celebrities, and historical figures. Its active users spend an average of two hours a day talking to the chatbots.

Beyond the states' claims, Character.AI has been sued by families who allege that its chatbots gave harmful advice, contributed to the suicides of two children, and exposed children to sexualized and bullying interactions. Character.AI has reached preliminary settlements with five of those families.

The company also faces investigations by the US government and by authorities in the UK, Italy, Russia and Australia.

Disney has agreed to pay $20 million to license the company's technology and intellectual property, as well as hiring most of Character.AI's staff, but is not interested in the type of data that the state AGs are worried about, Fay said. Disney's asset purchase must be approved by the bankruptcy court, and it is subject to higher offers.

Fay described a grim mood within the company in recent months, saying that employees "were very excited about the product and the user base" but had "lost faith in the company's trajectory."

The company attributed its bankruptcy to legal expenses and the high price for computing power and AI talent, saying it was losing between $8 million and $9 million a month before filing for Chapter 11 protection. 

Character.AI's management became concerned about its ability to survive employee attrition by late summer. In September, Disney stepped in to hire most of the company's employees and allow them to work on keeping Character.AI afloat during a bankruptcy sale process and technology transition, according to court filings.