A coalition of 31 states and the District of Columbia today asked the Delaware bankruptcy court to deny, or rewrite, the rules under which Character Technologies plans to sell a license to its AI technology to Disney. In a 27-page objection, the attorneys general argue that the proposed minimum overbid shuts out any rival offer between roughly $15.2 million and $21.7 million, even though every such bid would leave the estate better off than Disney's $20 million deal, and that the sale order would quietly ratify releases that Character granted Disney and its former chief executive before the company filed for bankruptcy.

In Short

Character.ai is in bankruptcy and wants the court to approve auction rules for selling a license to its technology, with Disney as the opening bidder at $20 million. Thirty-two state and DC attorneys general say the rules are tilted toward Disney: a rival would have to bid at least $21.7 million, even though anything above about $15.2 million would actually bring in more money, because Character keeps $5.5 million Disney already paid no matter who wins. They want the court to cut Disney's $700,000 fee, give rivals more time and access, and refuse to approve, through the auction rules, the legal releases Character handed Disney and its own former CEO before filing.

The filing

The document is Docket No. 66 in case 26-11603 (BLS), In re Character Technologies, Inc., before the US Bankruptcy Court for the District of Delaware. It was filed on October 23, 2026, the objection deadline set in the caption for 4 p.m. Eastern. The hearing on the bidding procedures is set for October 30, 2026, at 10 a.m. Eastern.

The objection targets the debtor's sale motion, Docket No. 15, which asks the court to approve bidding procedures and bid protections, designate Disney Worldwide Services, Inc. as stalking horse purchaser for what the filings call the Disney Target Assets, and authorize additional stalking horses. Abigail Rushing Ryan, bankruptcy counsel at the National Association of Attorneys General, signed for 28 states and the District of Columbia. Separate signature blocks appear for Colorado (Robert Padjen), Massachusetts (Meena Seralathan, Senior Trial Counsel in the Privacy and Responsible Technology Division), New Jersey (Thomas Huynh), Oregon (Justin D. Leonard) and Pennsylvania (Melissa L. Van Eck, of the Financial Enforcement Section).

The coalition is smaller than the one that filed a notice of interest on October 14. That filing, covered when Character.ai faced 40 attorneys general over who can buy its users' chats, carried 39 states and DC. Alaska, Georgia, Illinois, Indiana, South Dakota, Utah, Virginia and West Virginia signed the notice but do not appear on today's objection. The document gives no reason for their absence, and it does not say whether they support or oppose the procedures.

The states say they are not asking the court to unwind anything. "The States do not ask the Court to unwind the Debtor's prepetition decisions on this Motion," the objection says. "The States ask something narrower: that the Court not use a bidding procedures order to bless them, and that the procedures it does approve give competing bidders a fair opportunity to bid."

The two-stage deal, as the states describe it

The structure is not new to PPC Land readers. When the case opened, Disney budgeted $180m for Character.ai staff and $20m for the bankrupt company, and Character.ai lost 66 of its 86 staff to Disney ahead of the sale. What the objection adds is a reading of the contract language that the states say the motion understates.

According to the objection, Disney and Character signed a mutual non-disclosure agreement on August 19, 2026. On September 18, 2026, the company signed an Exclusivity and Prepayment Agreement, a binding term sheet and a transition services agreement. The states group the terms under seven headings:

  • Workforce. Disney got "the right to solicit and hire certain Company employees," required up to six Key Employees, one of them the chief executive, to accept and resign within ten days, and offered jobs to at least 60 others. Sixty-six of about 86 full-time employees accepted. Character now reports 18 active full-time employees, only 8 of whom are expected to stay through key portions of the case.
  • Covenant waivers. Character agreed not to enforce "any non-competition, non-solicitation, confidentiality or invention assignment covenant" against those employees with respect to Disney.
  • Releases. Character released Disney and every hired employee from all claims "from the beginning of time up to and through" September 18, 2026, including their use of "any Technology and Intellectual Property Rights developed by such employees . . . or otherwise developed or owned by the Company," and "any ideas, know-how and techniques." The release waives California Civil Code section 1542 and survives "indefinitely." The term sheet adds that Character "will 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."
  • Payment. Disney paid $7.5 million on signing, of which $5.5 million is "non-refundable in all circumstances" and $2.0 million is a refundable deposit.
  • Exclusivity. Until the petition date, Character could not talk to anyone about an IP license, "any financing, sale of equity, merger, recapitalization, liquidation or similar transaction," or "any hiring, engagement or transfer of any employees," and had to "terminate any access to any virtual or physical data room."
  • Control of the case. Disney set the venue and timeline, approves the bidding procedures in its "sole discretion," and is entitled to a sale order that is "final [and] non-appealable." That order must find the deal is not a sale of substantially all assets, that no employee transfers to Disney by operation of law, and that Disney is not a successor.
  • Other covenants. A three-year non-solicitation covenant protects Disney's new hires, and Character agreed not to meet any governmental authority about the transaction without Disney's consent, except as required by law.

That last covenant, the states write, "is difficult to reconcile" with the company's stated intent to use the case "as a forum to negotiate a consensual resolution with the Multistate Group" of 46 states and territories investigating it.

The objection sets the employee money against the estate's. Disney estimated annual compensation for the offered employees at about $60 million, plus a $30 million retention pool, for roughly $180 million over three years, which the term sheet says is "not . . . consideration payable to the Company." The estate, by contrast, "will receive at most $20 million in total (including the pre-petition payment of $5.5 million)."

A deal negotiated without a banker

One detail carries much of the argument. Character's first investment banker contacted about 28 parties between August 2025 and August 2026 and produced a single, non-actionable proposal; that engagement "concluded in late August 2026," the objection says, citing the first-day declaration of Colin M. Adams. The two parties that then negotiated in September came to management directly. The Restructuring Committee now running the case was formed only after a new independent director joined the board on October 1, 2026, nearly two weeks after the exclusivity agreement was signed.

The states quote the declaration of Adam Dunayer, the company's current banker, to close the loop: "[g]iven the timing of these negotiations relative to Houlihan's retention, Houlihan was not involved in these negotiations." The releases, exclusivity, milestones and 3.5% bid protections, the objection concludes, "were therefore negotiated without any investment banker." It adds that "the States do not question the independence of the directors involved," but that "the prepetition market check on which the Debtor relies did not test the transaction actually before the Court." The prepetition marketing was described in detail when Character.ai drew one unusable offer from 28 potential buyers.

The arithmetic of the overbid

The most concrete part of the objection is a table. Under the proposed procedures, a qualifying rival bid must beat the stalking horse agreement's $20 million value plus the $700,000 break-up fee plus $1,000,000, a floor of $21.7 million. The motion justifies that floor on the ground that the fee "will not diminish the Debtor's estate."

The states say that comparison leaves out the $5.5 million Character keeps whether or not Disney wins. Their table runs as follows:

Disney wins Competing bid of $X wins
Up-front payment retained by estate $5.5 million $5.5 million
Refundable deposit $2.0 million (applied) $0 (refunded to Disney)
Closing payment $12.5 million $X
Break-up fee paid by estate $0 minus $0.7 million
Net to estate $20.0 million $X + $4.8 million

"On these terms, any competing bid above approximately $15.2 million produces more for the estate than Disney's bid," the objection says. "The procedures nonetheless exclude every bid between $15.2 million and $21.7 million - a range of $6.5 million, or more than 40% above the break-even point. Excluding value-maximizing bids is the definition of a chilling term."

The states want the minimum overbid measured against the $14.5 million that remains at stake (the $20 million price less the $5.5 million already kept), plus any approved bid protections and a modest increment, and they want bids evaluated on the estate's net recovery. Neither the Adams nor the Dunayer declaration addresses the non-refundable payment, the filing notes.

Five other terms rivals face and Disney does not

Beyond the floor, the objection lists terms it says tilt the auction:

Closing deadline. Rivals must commit to close by November 30, 2026. Disney's own outside date is December 17, 2026. "Neither declaration explains the difference," the states write.

Access to staff. Only five Key Employees, chosen jointly by Disney and Character, must be available for diligence, and only up to 20% of their working time. Disney may also wall off up to 20% of hired employees from any rival's recruiting. "A non-exclusive license of AI training infrastructure and know-how has limited value to a buyer that cannot reach the people who operate it," the objection says, adding that a competing bidder "will depend almost entirely on personnel Disney now employs."

The release toll. To get transition services, a winning rival must release Disney from all claims since August 1, 2026, including claims over "any related intellectual property use, including with respect to the Licensed IP." In the states' words, "A bidder seeking to acquire the Debtor's technology must therefore waive claims for misuse of that same technology."

"Substantially the same terms." Qualifying bids must match or beat the stalking horse agreement, which includes the estate's general release and exculpation of Disney. The proposed sale order would also bar any future Chapter 11 plan from conflicting with the Disney agreements and permanently enjoin "litigation claimants" from suing any "Buyer Party," a term that covers Disney's employees.

All cash. The ban on non-cash consideration excludes royalties, earn-outs or assumed liabilities, structures the states say "could be worth more to a creditor body facing substantial litigation claims."

The $700,000 fee

The break-up fee is 3.5% of the $20 million price. In the Third Circuit, under Calpine Corp. v. O'Brien Environmental Energy (1999), such protections are allowed only if "actually necessary to preserve the value of the estate." The states say Character's own witnesses undercut that showing.

Disney committed to be the stalking horse before the filing, on pain of Character refunding its deposit. The Adams declaration states that "[t]he release in the EPA and the exclusivity period were critical to Disney to agree to serve as a Stalking Horse Purchaser." And the stalking horse agreement pays the protections "[i]n consideration for [Disney] having expended considerable time and expense in connection with . . . the hiring of former Licensor employees." The objection's response: "Disney's cost of hiring a workforce it keeps no matter who wins the auction is not a cost of preserving the estate."

If outbid, Disney still keeps the employees, the releases, the non-solicitation covenant and the 20% carve-out. "A party that keeps the most valuable part of the deal when it loses has little need to be compensated for losing," the states write. They also point to Dunayer naming Disney's agreement "to hire the majority of Character's workforce, including its chief executive officer," as the "first and foremost" reason it was chosen, while noting that Houlihan was not involved in negotiating the fee and so, in their view, has no personal knowledge of what induced Disney.

The coalition asks the court to deny the fee, or to limit it to documented, postpetition out-of-pocket expenses under a cap "substantially lower than $700,000," payable only from a closed alternative deal. It also opposes advance authority to grant 3.5% protections to any additional stalking horse designated by November 9, 2026, warning that the procedures "could stack a second 3.5% fee on the same assets."

Releases the states want kept alive

The legal heart of the objection concerns what the procedures order would find. Its proposed paragraph F says the procedures were "negotiated in good faith and at arm's length"; paragraph G calls the bid protections a "material inducement." The proposed sale order goes further, approving "the terms and all actions taken under the Exclusivity and Prepayment Agreement" and finding that Disney's "prepetition employment of the Debtor's former employees" was "part of the Transaction."

A debtor's release of its own claims is a compromise under Bankruptcy Rule 9019, the states argue, and Character has neither filed such a motion nor offered evidence on what it gave up. They raise the possibility that the releases are avoidable as constructive fraudulent transfers under sections 544, 548 and 550 of the Bankruptcy Code. The company reports $57 million in cash and no funded debt, so the states concede "balance-sheet insolvency may be disputed." But they cite the 46-member Multistate Group's claims, a burn rate of $8 million to $9 million a month and a prepetition runway the company itself calls "limited."

The sale also includes "any unreleased claims that the Debtor has against any of its former employees that accept offers of employment with Disney," which Character values at nothing. The states note that the company carries directors' and officers' liability insurance, a policy PPC Land covered when Character.ai paid $4.5m a year to insure its directors, so such claims may have value even if individuals could not pay. "A buyer acquiring the estate's claims against its own employees - including the Debtor's former CEO - is not purchasing an asset it intends to enforce," the objection says. "It is obtaining a release under another name."

The CEO disclosure

The objection also takes issue with a single sentence in the motion. Local Rule 6004-1 requires sale motions to highlight agreements with management. The motion states that "[t]here are no agreements between Disney and the Debtor's current management." The states call that accurate "only because the CEO's employment with the Debtor ended under the very transaction at issue." They ask for the offer letters and retention terms for every Key Employee, including the former CEO, the identity and terms of the rival proposal considered in September, committee minutes, any valuation of the released claims, and a redline of the original and amended transition services agreements.

They also flag an inconsistency. The Adams declaration describes the Disney agreement as a baseline for a sale covering "all or substantially all of the Debtor's Assets," and Dunayer describes the motion as seeking approval of "the Sale of substantially all of the Debtor's assets." Yet Disney's term sheet requires the sale order to find that the deal is not a sale of substantially all assets.

A calendar that runs into Thanksgiving

The proposed schedule sets a sale objection deadline of November 13, 2026, a bid deadline of November 20, an auction on November 23 and a sale hearing on November 24. That is 38 days of postpetition marketing, with objections due a week before anyone knows who the buyer is. "Creditors must therefore object to a sale before they know who the buyer is, what it will pay, or what releases it will demand," the states write.

They tie the timing to Third Circuit law. Under In re Boy Scouts of America (2025), a challenge to releases that form part of a section 363 sale's consideration becomes moot once the sale closes without a stay, so "the Sale Hearing may be the only meaningful opportunity to be heard on those releases." They cite In re Fisker (Bankr. D. Del. 2014), where the court found a holiday-straddling timetable "troublesome." And they quote the motion's own claim that Disney's payment "provides sufficient runway to market its Assets." "If the runway is sufficient, the compression is not driven by liquidity," the objection replies.

The states ask for at least 21 more days before bids are due, a sale objection deadline after the winning bidder is announced, and direct notice of the procedures to every party engaged before the filing, including the second September bidder. They also want Disney stripped of its consultation and advance-review rights over filings, and confirmation that nothing in the term sheet limits Character's communications with regulators, the US Trustee or any committee.

Notice to 12 million users

The final substantive section deals with notice. The proposed transaction notice says the assets will be sold "free and clear of all encumbrances." According to the states, it does not tell readers that the proposed sale order would permanently enjoin "litigation claimants" and "governmental, tax, and regulatory authorities" from claims "in any way relating to" the debtor against any Buyer Party, including the former CEO; bar successor and products-liability claims "now existing or hereafter arising"; approve the exclusivity agreement's releases; or treat anyone who does not object as having "consented."

"A creditor reading the Transaction Notice would have no reason to suspect that its claims against non-debtor individuals were at stake," the objection says. It notes the platform serves about 12 million monthly active users, that claims against the company "arise largely from minors' use of the platform," and that 46 states and territories are investigating. The states want a plain-language notice served on all personal-injury claimants and their counsel, including parties to the January 2026 settlements, on each member of the Multistate Group, and posted "on the Character.AI platform itself, not only on the Debtor's blog and community pages."

Questions about who receives which papers in this case are not abstract. PPC Land reported that Character.ai's bankruptcy notices still named 8 attorneys general out of office.

Rights reserved on user data

The objection is limited to the bidding procedures, and the states reserve a long list of issues for the sale hearing. One matters directly to the advertising and data side of the business: whether a consumer privacy ombudsman is required under section 363(b)(1), "given Disney personnel's access to user personal data under the TSA." The states cite New Jersey's investigation into Character.AI's prepetition safety and data practices, and the FTC and Texas inquiries into children's privacy, which PPC Land covered when Texas launched investigations into Character.AI and Meta. They also reserve arguments under Czyzewski v. Jevic Holding Corp. (2017) on the use of sale proceeds, and under Harrington v. Purdue Pharma (2024) on whether the sale order's injunction and release provisions exceed the court's authority.

Why this matters for the marketing industry

Character.ai is an ad-funded consumer AI product. The chief executive's first-day declaration put its advertising revenue at about $2.5 million a month against losses near $8 million a month, as covered when Character.ai lost $8m a month despite $2.5m in monthly ad sales. The Disney license excludes user data, chats and the app itself, which remain in the estate. Whoever controls that remainder, and on what terms, depends on whether the bidding framework survives in its current shape.

The objection also tests a deal pattern that has become common in AI: hire the team, license the technology non-exclusively, and leave the corporate shell behind. Here that pattern is running inside a bankruptcy court, and the states are asking the judge to look at the price of the people separately from the price of the assets. If the court accepts the argument that a non-refundable prepayment should lower the overbid floor, a rival bid between $15.2 million and $21.7 million becomes possible; if it does not, Disney's $20 million stands as the effective minimum.

For advertisers and platforms working with AI companion apps, the reserved privacy issues carry the most weight. A consumer privacy ombudsman, broad notice to minors' families and limits on what a buyer may do with conversation data would all shape what is sold and to whom. The October 14 notice of interest set nine conditions for any buyer, including honoring past advertising opt-outs. Today's objection does not repeat those conditions, but it keeps the question of user data open for the November sale hearing.

Timeline

  • August 2025 to August 2026: Character's first banker contacts about 28 parties; one non-actionable proposal results
  • January 2026: Character settles all then-pending personal injury lawsuits
  • August 19, 2026: Disney and Character sign a mutual non-disclosure agreement
  • Late August 2026: The first banker's engagement ends
  • September 18, 2026: Character signs the exclusivity and prepayment agreement, term sheet and transition services agreement; Disney pays $7.5 million, of which $5.5 million is non-refundable
  • October 1, 2026: A new independent director joins the board; the Restructuring Committee is formed afterwards
  • October 12, 2026: Character Technologies files for Chapter 11 in Delaware
  • October 13, 2026: The sale motion naming Disney as stalking horse is filed, on the deadline Disney set
  • October 14, 2026: 39 states and DC file a notice of interest
  • October 20, 2026: A Stretto affidavit shows notices addressed to 8 attorneys general no longer in office
  • October 23, 2026: 31 states and DC file their objection to the bidding procedures (Docket No. 66)
  • October 30, 2026, 10 a.m. ET: Hearing on the bidding procedures
  • November 9, 2026: Proposed deadline to designate additional stalking horse purchasers
  • November 13, 2026: Proposed sale objection deadline
  • November 19, 2026: Meeting of creditors
  • November 20, 2026: Proposed bid deadline
  • November 23, 2026: Proposed auction
  • November 24, 2026: Proposed sale hearing
  • November 30, 2026: Proposed closing deadline for competing bidders
  • December 17, 2026: Disney's outside date

Summary

Who: 31 states and the District of Columbia, led by NAAG bankruptcy counsel Abigail Rushing Ryan with separate counsel for Colorado, Massachusetts, New Jersey, Oregon and Pennsylvania, objecting to Character Technologies, Inc., operator of Character.ai, and its stalking horse purchaser Disney Worldwide Services, Inc.

What: A 27-page objection (Docket No. 66) asking the court to deny the proposed bidding procedures or modify them: strike the good-faith findings, preserve estate claims over the prepetition releases, drop the sale of claims against former employees, deny or cut the $700,000 break-up fee, lower the $21.7 million minimum overbid to reflect the $5.5 million already kept, equalize closing dates and employee access, extend the bid deadline by at least 21 days and rewrite the sale notice.

When: Filed today, October 23, 2026, ahead of the October 30 hearing on the procedures and a proposed November 24 sale hearing.

Where: The US Bankruptcy Court for the District of Delaware, case 26-11603 (BLS).

Why: The states argue that the procedures, written largely under terms Disney set before the filing, exclude rival bids that would pay the estate more, compensate Disney for benefits it keeps either way, and could cut off claims by users, families and regulators before a creditors' committee exists or the releases are reviewed.