DOJ seeks privacy protections for Character.AI users in bankruptcy sale

The bankruptcy and data risk

The Department of Justice (DOJ) is intervening in the bankruptcy proceedings of Character.AI, a platform that allows users to interact with fictional or imagined characters. The Executive Office for U.S. Trustees is seeking specific protections to prevent the sale of user chat histories to third parties. This move comes as the company faces a financial decline, partly due to lawsuits from families alleging mental health harms caused by the chatbot.

The DOJ's filing describes Character.AI as a 'first-in-kind super intelligence entertainment platform' where users engage in immersive, multimodal experiences. Because these interactions are often intimate, the government is concerned about the scale of the data at risk. With 12 million monthly active users spending an average of two hours a day on the site, the volume of personal information is significant.

The court currently holds the power to restrict how data is sold during the reorganization process. The DOJ argues that the company's current privacy policy is 'ambiguous' regarding what can be sold. They are pushing for a consumer privacy ombudsman to oversee the legalities of any potential data transfers to ensure user rights are not ignored for the sake of a sale.

Opaque policies vs. chatbot promises

There is a notable discrepancy between how the Character.AI chatbot speaks to users and what the company's legal documents actually say. When users ask the chatbot if their conversations are private, the AI claims to provide a 'safe, confidential space' and promises not to share data without explicit permission. However, the DOJ notes that the actual privacy policy is much less clear and more permissive.

The company's legal terms, which were updated on July 1 while the firm was actively seeking to sell its assets, allow for the disclosure of personally identifiable information (PII). The policy specifically permits the transfer of this PII if the company is sold or undergoes a reorganization. This creates a situation where users might believe they are in a private sanctuary while their data is legally positioned as a corporate asset.

The DOJ is demanding that Character.AI provide a record of all previous versions of its privacy policy. They want to know if the company ever disclosed that PII could be transferred during a sale or reorganization. The government wants to see how these changes were communicated to the public and whether the company provided sufficient notice to its millions of active users.

The risk of identifying users

Privacy experts warn that even if names are removed from chat logs before a sale, the content of the conversations can still identify individuals. Because people often share specific and intimate details with chatbots over several months, the data remains highly personal. AI technology also makes it easier for third parties to infer sensitive traits from these detailed logs, even if the data is purportedly anonymous.

Sydney Saubestre, a senior policy analyst at the Center for Democracy and Technology, noted that the company's policy allows for data disclosure regardless of user expectations. She pointed out that a new buyer could potentially change privacy practices if they offer incentives to consumers to consent. This means that once the data is sold, the original protections promised by the company may no longer apply to the user.

The DOJ's request for an ombudsman is specifically aimed at protecting sensitive content, such as data belonging to minors. They want to ensure that health data, demographic information, and any other details that users reasonably expect to be private are handled correctly. The goal is to align any potential sale with applicable laws and the specific opt-outs that users may have already selected.

Broader trends in data sales

The Character.AI situation is part of a growing trend where personal data is treated as a primary asset in bankruptcy cases. For example, a March 2025 bankruptcy case involving 23andMe saw personal data being treated as a sellable commodity. These cases show that when companies fail, the data of their users often becomes a tool for debt repayment or corporate restructuring.

Federal lawmakers have recently sounded alarms about similar deals involving other tech giants and defunct companies. One such instance involved a pending deal between Google and a defunct airline, where $10 million was offered for employee personal data to be used for model training. These incidents highlight a recurring concern: the transition of private personal information into a commercial asset for AI development or other corporate uses.

The DOJ's move to intervene in the Character.AI case suggests a shift toward more active oversight of AI data. By seeking a court-appointed ombudsman, the government is attempting to create a layer of protection between the user and the auction block. This could influence how other AI companies structure their privacy policies and how courts handle the liquidation of sensitive digital content in the future.