Character Technologies, the bankrupt operator of Character.ai, asked the US Bankruptcy Court for the District of Delaware on October 27, 2026, to overrule objections from a coalition of states and the US Trustee and approve auction rules built around Disney's $20 million bid, without lowering the $21.7 million floor that rivals must clear or the $700,000 fee Disney would collect if outbid. The omnibus reply, filed after the court's reply deadline together with a motion asking permission to file it late, also says the company would consent to a consumer privacy ombudsman "under appropriate circumstances" and answers, line by line, the nine safety and privacy conditions the states set for any buyer.

In Short

Character.ai is bankrupt and wants a judge to approve the rules for auctioning its technology, with Disney as the opening bidder at $20 million. State attorneys general and the US Trustee, the Justice Department office that polices bankruptcy cases, said those rules favor Disney; the company now answers that Disney's terms, including a $700,000 payment if it loses, are fair because Disney is also supplying staff and services that the company values at more than $5 million. Character.ai made some changes, such as stating that the auction rules do not approve Disney's whole deal, but kept the minimum price rivals must offer and said it could accept an independent privacy reviewer for user data under the right conditions. The judge hears the dispute on October 30, 2026.

The filing

The document is Docket No. 73 in case 26-11603 (BLS), In re Character Technologies, Inc. It runs 37 pages: a six-page motion for leave to file a late reply, a proposed order, and the reply itself as Exhibit B, which consists of a 16-page brief and a 10-page chart answering the objections issue by issue. Wilson Sonsini Goodrich & Rosati signed it in Wilmington, through Erin R. Fay, Shane M. Reil and Heather P. Lambert, as proposed counsel to the debtor.

The reply answers four filings. Two are the October 14 notice of interest from the state attorneys general (Docket No. 33) and a joinder to that notice by the Florida Attorney General (Docket No. 58). Florida was not among the 39 states and DC that signed the original notice, which PPC Land covered when Character.ai faced 40 attorneys general over who can buy its users' chats. The other two are formal objections: one by the coalition of states (Docket No. 66), reported when 32 states said Character.ai's sale rules block bids that would beat Disney, and a new one from the Office of the United States Trustee for the District of Delaware (Docket No. 69), filed on October 27.

Why the reply is late

Under Delaware Local Rule 9006-1(d), reply papers are due at 4 p.m. Eastern the day before the hearing agenda must be filed. The agenda for the October 30 hearing is due at noon on October 28, which put the reply deadline at 4 p.m. on October 27. The general objection deadline had been October 23 at 4 p.m., set under an order shortening notice (Docket No. 43).

According to the motion, the company "extended the Objection Deadline for the U.S. Trustee several times, including a final extension that was shortly after the Reply Deadline" - to 5 p.m. on October 27, one hour after its own reply was due. The extensions did not produce a full settlement, the motion says, but "the issues between the parties were substantially narrowed." The company also says it shared the chart of responses with the states' counsel before the reply deadline and that it received informal comments on the sale motion from parties it does not name.

The proposed order would deem the reply, and any joinders to it, timely filed. The US Trustee's own objection is not part of Docket No. 73; its arguments appear here only as the company summarizes and quotes them.

The company's account of how it got here

The preliminary statement sets out a version of the prepetition months that differs in emphasis from the states'. Character says it ran "an extensive, year-long search" for acquirers or partners and heard "consistent feedback" that, although its product and user base were impressive, "the litigation and regulatory environment surrounding the Debtor's product created significant transaction uncertainty." It names three pressures: attrition "in the highly competitive AI talent market," which it describes as an operational risk because it "requires key personnel to constantly monitor and ensure user safety"; the cost of running the platform; and "mounting legal expenses in connection with the States' litigation and investigations."

The language on the states is pointed. "Indeed, the Debtor vehemently disagrees with the States' contention that the Character.AI platform is unsafe or misleading to consumers," the reply says. Given the risk that the platform "that is beloved by millions of users will be shut down" if no sale succeeds, it adds, "the States appear intent on continuing value-destructive efforts to legislate through litigation against the Debtor."

The reply says Character "received interest in a strategic transaction from Disney and one other party in or about August of 2026," and that its Initial Transaction Committee judged Disney's proposal superior on value, actionability and the path to further value. It does not name the second party. The states had asked for that party's identity and the terms of its proposal to be filed before the sale hearing; the chart says the company "has made accurate disclosures in the Bid Procedures Motion" and lists no further disclosure.

When the committee was formed

One factual point goes directly to the states' argument. Their objection said the Restructuring Committee was formed only after a new independent director joined on October 1, 2026, roughly two weeks after the September 18 exclusivity agreement. In the chart's own summary of that objection, the deal terms were "fixed before the Restructuring Committee existed and without an investment banker."

The chart answers that "the Initial Transaction Committee, which then became the Restructuring Committee, was formed in early September 2026, oversaw and directed the negotiation regarding, and approved the Disney transactions, and bid procedures." The brief adds that both bodies were "comprised solely of independent directors." The reply does not contest that Houlihan, the current banker, was absent from the September talks. It says instead that the bidding procedures themselves "were developed in close consultation" with Houlihan Lokey. The earlier declaration from Houlihan managing director Adam Dunayer was covered when Character.ai drew one unusable offer from 28 potential buyers.

To keep the good-faith findings in paragraphs F and G of the proposed order, the company cites two Delaware cases in which similar findings were entered: True Value Company (Case No. 24-12337) and PLX Pharma (Case No. 23-10456).

The money: the floor, the fee and $5 million in services

The states' central argument was arithmetic. Disney paid $7.5 million on September 18, of which $5.5 million is non-refundable, so, in their calculation, any rival bid above about $15.2 million leaves the estate better off than Disney's $20 million. Yet the proposed procedures require a qualifying overbid of at least $21.7 million: $20 million, plus the $700,000 break-up fee, plus a $1 million minimum increment. Those mechanics were first set out when Disney budgeted $180m for Character.ai staff and $20m for the bankrupt company.

The answer is short. "The Debtor is not proposing any change to the minimum overbid or successive bid increments," the chart says. The total price under the stalking horse agreement is "$20 million in cash plus numerous other benefits by way of the TSA," the brief argues, and "Disney should not be penalized for having advanced $5.5 million of that price prepetition." The chart, making the same point, puts the advance at "$7.5 million of that consideration." Both figures match the deal terms - $7.5 million paid, $5.5 million of it non-refundable - but the two halves of the reply use different numbers for the same argument.

Two clarifications narrow what the floor covers. According to the brief, the $1 million minimum increment "applies only to bids that would top the $20 million Disney proposal." The chart goes further: the overbid requirements "only apply to bids that seek to make the bid of a Stalking Horse Purchaser (including Disney) not able to be consummated." Read together, a bid for assets that does not displace Disney's non-exclusive license - the app, the brand or the user base, all of which sit outside the Disney deal - would not need to clear $21.7 million. The reply does not set a separate floor for such bids. Houlihan, it says, set both the $1 million minimum and the opening auction increment "on the basis of its experience," and the company can change increments during the auction on notice.

The $700,000 break-up fee

The bid protections equal 3.5% of the $20 million cash price, or $700,000. In the Third Circuit, such protections must be "actually necessary to preserve the value of the estate," the standard from Calpine Corp. v. O'Brien Environmental Energy that the states invoked. The company's case rests on three points.

First, necessity. "The Bid Protections were a negotiated component of the overall transaction since the outset, as reflected in the parties' term sheet," the reply says. "It is simply inaccurate to say that Disney would have agreed to act as a stalking horse bidder without the Bid Protections."

Second, size. The company lists four Delaware cases as comparables:

Case Case No. Order date Bid protections
American Tire Distributors 24-12391 (CTG) November 26, 2024 4% of the cash portion of the price
SunPower 24-11659 (CTG) August 29, 2024 3% of the price
Express (EXP OldCo Winddown) 24-10831 (KBO) June 6, 2024 almost 6% of the price
Zymergen 23-11661 (KBO) November 20, 2023 3.2% of the price

Character's 3.5% sits inside that range.

Third, and most consequential, total value. The company "estimates the overall cost-savings from Disney's willingness to extend employment offers to the Debtor's employees and provide the free TSA services itself exceeds $5 million." "As such, the actual transaction value to the Debtor is much higher, but Disney agreed to a break-up fee based solely on the cash price," the brief says. It adds that Disney "could have sought to include" the free services in the base for the fee. The reply gives no breakdown of the $5 million estimate and does not say whether it covers the transition services alone or also the wages Character no longer pays to staff who moved to Disney. The chart says Character is "prepared to proffer additional testimony on the significant interest and value maximizing sale process that is unfolding," without describing that interest.

On the states' point that the $5.5 million is kept whatever happens, the reply says that argument "ignores the totality of benefits provided by the Disney transaction" and that "Disney was under no obligation to structure its bid such that the Debtor would receive $5.5 million of the purchase price up-front and on a fully non-refundable basis." "Disney should not be penalized for granting meaningful concessions," it concludes.

Two closing dates and the staff Disney now employs

The states objected that rivals must close by November 30, 2026, while Disney's outside date is December 17, 2026. The reply calls the complaint "a fundamental misunderstanding of the facts and circumstances of this case." The Disney deal is a license that does not require Character to keep running the app. A bid "that would see the platform continue," by contrast, means the company must keep operating it until closing, "as the cost of maintaining the safe operation of the platform through approval and closing is substantial." "Put simply, given the Debtor's substantial cash burn, time is of the essence," the brief says. "The Debtor determined the closing date for competing bidders in consultation with its advisors; Disney had no role in selecting such date." If bidders propose a different date, the chart adds, the company will discuss it then.

The chart puts the burn at $8 million to $9 million a month, consistent with the first-day figures reported when Character.ai lost $8m a month despite $2.5m in monthly ad sales. It also states plainly what happens without a platform buyer: the timeline accounts for "the need to wind down the platform safely and with the support of Disney's transition services within the transition services period if a full platform sale is not possible."

The 80% figure

The reply states as a term what earlier coverage had to infer. Disney "agreed to provide transition services to one Winning Bidder under the terms of the Winning Bidder TSA, and to permit such Winning Bidder to extend employment offers to 80% of the Debtor's former employees now with Disney and to work in good faith to transition such employees should they accept." The workforce move itself was reported when Character.ai lost 66 of its 86 staff to Disney ahead of the bankruptcy sale. The states had asked that all hired employees be made reasonably available, with no carve-out. "It is not workable or necessary for the Debtor to access the entire former workforce for diligence," the chart replies, adding that "Disney was under no obligation to agree to these provisions."

The release for transition services

The states objected to a condition that a winning rival release Disney from all claims since August 1, 2026, including those relating to "any related intellectual property use, including with respect to the Licensed IP," in exchange for transition services. The company does not drop it. "Disney is unwilling to provide transition services without the release," the chart says. "If a bidder does not want to agree to the release, that is acceptable, but if it wants such services, it must provide a release. If bidders raise issues with this, the Debtor will discuss with Disney."

The services are limited to one winner for a practical reason, according to the chart: "It is impractical for the Transferred Employees to provide transition services to more than one Winning Bidder and also do their jobs for Disney." Terms such as the release and the requirement that directly competing bids be on "substantially the same or better terms" are, in the company's and Disney's view, "standard in cases of this kind," and "relatively favorable to the estate" compared with what some stalking horse bidders demand.

What changes in the revised order

The reply was filed alongside a revised proposed bidding procedures order, which is not part of Docket No. 73. The chart describes the changes it makes or promises:

  • No approval of the Disney deal. A new sentence in paragraph 1 reads: "Notwithstanding anything to the contrary herein, this Order does not approve the full terms of the Stalking Horse Transaction Agreement or permit the Debtor to consummate the transactions set forth therein other than the Bidding Protections." The reply says the portions of the sale motion seeking approval of the transactions are not before the court on October 30.
  • No Disney release in rival sale orders. The revised order clarifies that competing bidders do not have to include a release or exculpation of Disney in their proposed sale order, "which was never the case in any event." Disney's form of sale order "can serve as the base for other bidders, but such bidders can make any changes they propose."
  • A supplement for any additional stalking horse. Before granting protections to a further stalking horse, the company would file an "Additional Stalking Horse Supplement" disclosing the bidder's identity, price, agreement, connections to the debtor and bid protections, with a hearing at least three days later and objections due at that hearing. It cites Quanergy Systems (Case No. 22-11305, entered December 21, 2022). On the states' fear of a second 3.5% fee on the same assets, the chart says "an Additional Stalking Horse bid cannot conflict with Disney's bid, so 'fee stacking' is not possible."
  • Communications with regulators. The company will add language that nothing in the exclusivity and prepayment agreement limits its ability to communicate with governmental units, the US Trustee or any committee. It says the agreement never imposed such a limit; Disney is to be consulted only on meetings with authorities about the license transaction, which the company "does not believe is implicated by current discussions with governmental authorities."
  • A new transaction notice. "The Debtor will propose a revised notice to address these concerns," the chart says of the states' complaint that the notice did not disclose the injunction against "litigation claimants" or the successor-liability bars.
  • A form of purchase agreement. The company will file a form asset purchase agreement for buyers other than Disney.

What the company refuses

Several requests are rejected outright.

A challenge period. The states asked for at least 60 days for a future creditors' committee to challenge the prepetition releases. "The Debtor submits that the Bidding Procedures Order is not a financing order and a challenge period is not appropriate or necessary," the chart says, noting that the sale motion has been on file since October 13, 2026.

Claims against former employees. The states wanted the estate's unreleased claims against employees who joined Disney, including the former chief executive, taken out of Disney's package or sold separately. The response is two sentences: "The Debtor is marketing any and all of its assets, together or separately. Parties are free to bid on any assets they would like."

Later sale objections. Moving the sale objection deadline after the winner is announced is "not practicable, possible, or necessary," according to the chart, which points to existing provisions for objections on cure amounts, contract assignment and the conduct of the auction.

Non-cash bids. The all-cash rule stays, but the company reads it broadly: cash "would encompass cash paid as a part of a royalty or earn-out," and buyers must state which liabilities they assume.

Disney's information rights. Disney receives advance copies of pleadings, which the chart calls typical for a stalking horse. It adds that "Disney is not a Consultation Party and will not receive advance copies of bids."

The calendar. The states asked for at least 21 more days before the November 20 bid deadline. The company says it set the timeline against its own budget while negotiating it with Disney, and cites three Delaware cases. In Jo-Ann Stores (Case No. 25-10068), the bid deadline came 34 days after the petition and the sale objection deadline 36 days after; in True Value, both fell 25 days after; in Food52 (Case No. 25-12277), sale objections were due at 29 days and bids at 36. By PPC Land's count, Character's bid deadline falls 39 days after its October 12 petition and its sale objection deadline 32 days after. Character's bid window is longer than in all three. But in two of the three, objections were due on or after the bid deadline, which is the sequencing the states asked for. The reply also says the procedures already require notice to every party that expressed interest in the company's assets in the past year.

The safety and privacy chart

The longest new material in the filing is a table answering the nine demands from the states' notice of interest. The company says the platform "significantly complies" with them and "largely comports" with them, and that the states' notice "glosses over or simply ignores" changes it made voluntarily. Those include a separate model for under-18 users deployed in November 2024, with filtering updates, "time spent" notifications and a parental insights tool, and processes introduced "over several months beginning in October 2025" that eventually eliminated open-ended chat for users under 18.

Age assurance

The states asked for age assurance that does not rely solely on self-declared birthdates. The company describes a "neutral age gate" at registration, followed by a process "combining technical measures, analysis of various user-activity signals, and third-party verification technology." A user the system classifies as likely under 18 is notified and moved automatically to the under-18 experience. A user who disputes the result can verify age with a selfie "processed by a reputable third-party verification provider," and must upload a government ID if the selfie cannot confirm adulthood. The provider is not named. The system is "subject to ongoing accuracy monitoring and periodic review," according to the chart, which gives no accuracy figures.

Trust and safety staffing

Under-18 users cannot hold open-ended chats and are blocked from restricted content across the platform, including Stories, according to the response. The company says it uses "a team of roughly 79 individuals" to uphold its trust and safety policies, plus AI "classifiers" that filter content, characters and user-uploaded images for sexual content, sexual content involving minors, violence, self-harm and eating disorders, and hate speech. Under the transition services agreement, it also has access to "roughly 17 individuals now employed with Disney who can assist in this area."

The chart does not say how many of the 79 are employees. The states' objection, citing the company's first-day papers, put Character's active full-time headcount at 18, and the filing does not reconcile the two figures.

Disclaimers on professional characters

The states asked for the removal of characters that hold themselves out as therapists, doctors, lawyers or other licensed professionals. The company disputes that its characters mislead anyone and quotes its disclaimers. Every character carries the line: "This is an A.I. chatbot and not a real person. Treat everything it says as fiction. What is said should not be relied upon as fact or advice." Characters that refer to licensed professionals add: "This is not a real person or licensed professional. Nothing said here is a substitute for professional advice, diagnosis, or treatment."

The reply does not mention removing any such character. The issue has a record: in May 2026, Pennsylvania's medical board sued Character.AI over a bot posing as a licensed psychiatrist that, according to the complaint, supplied a license number matching no valid Pennsylvania medical license.

Crisis response

On crisis safeguards, the company describes a pop-up triggered by words or phrases related to suicide or self-harm that points to "a non-profit, global helpline that offers free, anonymous emotional support," and a dedicated pipeline called Guardian. Guardian assigns a risk level from various signals and surfaces support ranging from in-chat resources to "handoff to licensed professionals." A footnote limits the claim: "Guardian is designed to surface help to users who may be at risk rather than to remove content. It is not a clinical intervention." The states had asked for protocols that "cannot be defeated with a simple click-through." The response does not address that phrase directly.

Advertising and data

Four rows deal with data, and they matter most to the advertising side of the business. Set side by side, the demands and the responses do not fully match.

  • Advertising opt-outs. The states asked for account-level opt-outs from sales of personal data and targeted advertising, and for opt-outs consumers had already exercised to be honored. The company says it "provides sale-of-data and target-advertising opt outs for all users in states where legally required to do so at the account level and honors such opt outs." That limits the commitment to states where the law requires it, and the response does not mention opt-outs exercised before.
  • Secondary use of chats. The states asked the company to refrain from using chat content to train or fine-tune models, or for advertising or other commercial purposes, beyond what users validly consented to. The response: "Character does not share chat content for advertising purposes," and "Users in the United Kingdom and European Union can opt out of their data being used to train the Company's models." The wording addresses sharing, not internal use for advertising, and offers a training opt-out only in the UK and EU.
  • Access and deletion. The states asked that all consumers be able to delete their data before any sale. The company says it "allows users to request export and/or deletion of their data through its automated systems and honors such requests." Timing relative to a sale is not addressed.
  • Privacy program. The company points to its terms, privacy policy and regional disclosures, internal restrictions on data use and risk assessments, and says it "obtains user consent where required."

These are not abstract questions for Character. In August 2025, PPC Land reported that Texas launched investigations into Character.AI and Meta over children's privacy, examining whether chatbots presented as mental health tools misled users while the terms of service disclosed that interactions were logged and used for advertising and algorithm development. A month later, the FTC ordered seven AI chatbot companies, Character Technologies among them, to detail child safety measures, including monetization and data handling.

User data and the ombudsman

The US Trustee now argues that a consumer privacy ombudsman must be appointed, according to the chart's summary of its objection. The states had only reserved the point, citing Disney personnel's access to user data under the transition services agreement and the pending multistate, FTC and Texas investigations.

The company's legal position has not changed. "The Debtor believes that its privacy policy, as in force on the Petition Date, permits the sale and transfer of user data in connection with this Chapter 11 case and, therefore, a consumer privacy ombudsman ("CPO") is not required here," the brief says. When a debtor's privacy policy bars the transfer of personally identifiable information, section 363(b)(1) of the Bankruptcy Code generally requires an ombudsman before the court can approve a sale of that data.

Its practical position has moved. "Nonetheless, the Debtor is willing to consent to the appointment of a CPO under appropriate circumstances," the reply continues, recognizing "that the Debtor is operating under substantial liquidity constraints and thus cannot support a substantially extended process." The company and the US Trustee are in discussions, and it is "hopeful that this issue can be resolved consensually in advance of the hearing." A footnote reserves all rights and notes that the US Trustee's objection "was filed shortly prior to the Debtor's deadline to file this Reply."

Disney wants its own deal kept out of any review. "Disney has no access to the Debtor's user data and is not purchasing personally identifiable information," the chart says. "Disney does not believe that the Stalking Horse Transaction Agreement should be reviewable by a consumer privacy ombudsperson because PII is an excluded asset." That fits the structure reported when Disney paid $20m for Character.ai's IP and $180m for its staff: the license excludes the app, the brand, user data and chats.

One tension is left unresolved. The same filing says about 17 people now employed by Disney can assist with trust and safety under the transition services agreement - work that, as the chart describes it, involves filtering user content and uploaded images. The reply does not explain how that assistance is performed without access to user data, or whether the "no access" statement refers to Disney as a company rather than to staff acting for the debtor under the agreement.

Why this matters for the marketing industry

Character.ai is an ad-funded consumer AI product with an app, a brand and a user base that no stalking horse has bid for. The reply confirms what happens if nobody does: a supported wind-down within the transition services period. If a platform buyer does emerge, a bid that leaves Disney's license in place would not need to clear the $21.7 million floor, according to the chart, but it would have to close by November 30 and, if it wants transition services from Disney's staff, release Disney from claims, including those over the licensed technology.

The data questions follow whichever path wins. The company's view that its privacy policy already permits the transfer of user data is the threshold question for any ombudsman, and the US Trustee is now pressing it. The answers to the states' advertising conditions are narrower than the demands: opt-outs only where state law requires them, a commitment not to share chat content for advertising rather than not to use it, and a training opt-out limited to the UK and EU. For buyers of distressed data assets, the precedent is recent. PPC Land reported in August 2026 that Google won bankrupt Spirit Airlines' data for $10 million, in a sale that excluded customer profiles and required a third party to remove personal data before delivery.

The filing also shows how a court treats an acqui-hire carried out on the eve of bankruptcy. The company's argument for Disney's fee rests partly on the value of Disney taking on Character's former staff and lending them back at no charge, which it puts at more than $5 million. The states argued that a bidder who keeps the people whether it wins or loses needs little compensation for losing. The October 30 hearing is set to be the first time the judge weighs those two accounts of the same arrangement.

Timeline

Summary

Who: Character Technologies, Inc., operator of Character.ai, represented by Wilson Sonsini Goodrich & Rosati, answering objections from a coalition of state attorneys general (with Florida joining the earlier notice of interest) and the Office of the United States Trustee for the District of Delaware, in a sale with Disney Worldwide Services, Inc. as stalking horse purchaser.

What: A late omnibus reply and motion for leave (Docket No. 73) asking the court to overrule the objections and approve the bidding procedures. The company keeps the $21.7 million minimum overbid and the $700,000 break-up fee, which it justifies with more than $5 million in claimed savings from Disney's hiring and free transition services. It adds language that the order does not approve Disney's deal, a disclosure-and-hearing step for any additional stalking horse, and a revised sale notice; it rejects a challenge period, later sale objections and changes to the release Disney requires for transition services. It answers the states' nine safety and privacy demands point by point, and says it would consent to a consumer privacy ombudsman under appropriate circumstances while maintaining that its privacy policy permits the transfer of user data.

When: Filed October 27, 2026, after the 4 p.m. reply deadline and on the day the US Trustee filed its objection, ahead of the October 30, 2026 hearing.

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

Why: The company argues that its cash burn of $8 million to $9 million a month leaves no room for a longer process, that Disney's concessions made a sale process possible at all, and that the objections either concern the later sale hearing, are resolved by the revised order, or lack merit. The outcome sets the terms on which any buyer can bid for the app, its users and their data.