Character.AI Bankruptcy Was Part of Disney Deal, Court Filings Show

Character.AI's bankruptcy was not a simple collapse. According to court filings reviewed by Wired, the chapter 11 petition filed on October 12 was a required step in a deal with Disney, which has hired the "majority" of the startup's employees, including now-former CEO Karandeep Anand, and is bidding for broad rights to its technology. The arrangement is designed so that whatever remains of Character.AI keeps responsibility for its legal battles, some of which are ongoing.

The deal involves what filings describe as "two interrelated and integrated" transactions. In September, Disney paid Character.AI $5.5 million plus a refundable $2 million good faith deposit, hired most of its staff, and agreed to let some of those now-Disney employees keep the startup running for five months. A motion filed by Character.AI's legal counsel says Disney required the deal to be "fully consummated" through bankruptcy because of the startup's shrinking cash reserves and significant litigation and regulatory risks.

Through the bankruptcy, Disney hopes to secure a perpetual, worldwide, nonexclusive license covering a wide range of Character.AI's code, documentation, frameworks and tools, including its trust and safety moderation stack, training infrastructure and age-prediction technology. Users' data and the Character.AI website are not included in the listed intellectual property. That license will be auctioned in the coming months; if Disney wins and courts approve, it will pay an additional $12.5 million, while losing bidders refund Disney its deposit and a breakup fee.

Disney also agreed to let the eventual winning bidder interview and potentially make offers to up to 80 percent of "certain newly hired employees" it took from Character.AI, with Disney choosing which ones. Experts told Wired that moving workers between companies again within months is unrealistic and that the arrangement would be hard to unwind. Disney has prepared a draft "363 Free and Clear Order" stating the process is not a merger and that Character.AI remains responsible for any liability or obligation, including legal claims.

"There's decades of corporate law that developed to deal with the problem of a buyer who always wants to take on all the assets and never wants to take on any of the liability," said John Newman, a University of Memphis School of Law professor and former deputy director of the Federal Trade Commission's Bureau of Competition. He called the Disney-Character.AI structure extremely unusual, saying existing corporate law safeguards "really weren't built to guard against" it. Character.AI referred Wired to Disney on whether the deal depended on bankruptcy; Disney declined to comment, and Character.AI said it could not speculate on the outcome.

This is not Character.AI's first such arrangement. In August 2024, Google reportedly paid $2.7 billion to license its technology and hired its founders and ML pre-training research team, while most employees stayed. Google was later named alongside Character.AI in lawsuits, including one alleging a 14-year-old boy died by suicide after a chatbot relationship; a judge found the plaintiff sufficiently alleged Google was liable for aiding and abetting. The companies agreed in January to settle that and similar cases, with a referee approving the individual settlements on October 11, the day before the bankruptcy filing. Filings also note Character.AI struggled with profitability "at all times," and that by August 2025 bankers found its litigation and regulatory overhang made it unbuyable, with state attorneys general launching an investigation that November.