Artificial Intelligence and Fraud: A Bankruptcy Practitioner’s Perspective

This article was originally published in the Fall 2025 issue of The Federal Lawyer.

By Briana Breault

The bankruptcy world is not immune to the reach of artificial intelligence. Two recent cases filed in the U.S. Bankruptcy Court for the District of Delaware offer insight for bankruptcy practitioners in the ever-evolving landscape of AI.

Builder.ai: “AI Washing” and Due Diligence

Engineer.ai, aka Builder.ai, once valued at $1.5 billion and backed by Microsoft, serves as a cautionary tale for the rapidly evolving AI landscape.1 Builder.ai filed its Chapter 7 petition, following allegations that Builder.ai faked business with an Indian social-media startup, VerSe Innovation, for years to falsely inflate its sales.2 Garnering worldwide attention, the case showcases the phenomenon known as “AI washing.” AI washing is defined generally as “overstating [a company’s] use of AI or the capabilities of AI on their business.”3

AI washing presents unique challenges for legal professionals, including those who represent creditors and debtors. For counsel representing investors, the case of Builder.ai underscores the need to conduct comprehensive due diligence when evaluating AI startups. Creditors’ counsel can no longer accept technological claims at face value. For example, practitioners should consider scrutinizing not just financial projections but the very technological claims underlying a business. In Builder.ai, the “AI” was reportedly human engineers, who were responsible for most of the coding.4 Given the risk of inflated valuations and questionable technology, creditors’ attorneys should focus on identifying and securing tangible, verifiable assets.

Counsel representing debtors in the AI industry should be prepared for complicated tasks, such as valuing AI assets like algorithms, datasets, and intellectual property, especially when their efficacy or even existence is disputed. Debtors’ counsel must guide clients on realistic valuations, especially in unproven technological sectors. It’s no longer enough for AI companies to simply claim they use AI. Attorneys should counsel debtors to have verifiable evidence of their AI’s efficacy and actual use. This means scrutinizing the technological claims deeply and ensuring they align with operational reality. When fundraising or seeking investment, debtors must be prepared for unprecedented levels of due diligence. Attorneys need to advise clients to fully disclose the true nature of their technology, avoiding any misrepresentation that could later be deemed fraudulent. This includes clearly distinguishing between AI-driven processes and human intervention.

The fall of Builder.ai serves as a reminder that artificial intelligence must be met with scrutiny. As instances of AI washing continue to rise, bankruptcy practitioners will continue to face challenges, underscoring a need for enhanced due diligence, transparent disclosures, realistic valuations of AI assets, and verifiable evidence of the technology’s efficacy. Augustus Intelligence: Avoiding Fraudulent Schemes and Navigating Jurisdictional Complexities In the case of Ryniker v. Washington (Adv. Pro. No. 23-50370 (TMH)), the Trustee for Debtor Augustus Intelligence, Inc. brought an adversary proceeding against a certain key investor.5 The Trustee pursued two types of claims: those on behalf of the Augustus Intelligence, Inc. estate (“Estate Claims”) and claims assigned to the Trustee by certain investors (“Assigned Investor Claims”).6

Augustus Intelligence, Inc. was incorporated in Delaware in 2018 to develop artificial intelligence solutions.7 The core of the dispute revolved around a failed investment in Augustus Intelligence, Inc. The founder of Augustus Intelligence, Inc. had sought a significant investment from the defendant investor, who was presented as a crucial lead investor to attract other outside investors.8

Although the founder and defendant investor agreed to execute a written investment agreement to be used to solicit investments, investors were unaware of a secret, verbal side deal which negated the defendant investor’s firm commitment to invest.9 Augustus Intelligence, Inc., relying on the written investment agreement and the defendant investor’s promise to invest $50 million, raised $30 million through other investors and hired dozens of employees.10 When defendant investor failed to contribute the $50 million, the newly hired employees were fired, leading to negative press.11

Like Builder.ai, Augustus Intelligence, Inc. highlights how quickly promising AI companies can devolve into alleged fraudulent operations. When advising a startup combining AI with emerging, less regulated fields like cryptocurrency, attorneys must perform extensive due diligence on the business model itself. They should identify and mitigate risks of the venture being perceived or actually used as a vehicle for fraud. Even with novel technologies, basic principles of contract law and anti-fraud statutes apply. Debtor’s counsel must ensure that all agreements, especially investment contracts, are legally sound. Creditors’ counsel should be aware that bankruptcy courts may lack subject matter jurisdiction over claims between non-debtors, even if those claims stem from AI-related fraud that led to the debtor’s bankruptcy.

 

Takeaways

Both cases underscore that the unique characteristics of AI demand a more sophisticated and cautious legal approach from both debtors’ and creditors’ attorneys. They emphasize the need for legal professionals to be not just legal experts, but also technologically savvy, or at least capable of effectively collaborating with technical experts. The fall of Builder.ai and Augustus Intelligence, Inc. serve as reminders that artificial intelligence must be met with scrutiny. As instances of AI washing and AI fraud continue to rise, bankruptcy practitioners will continue to face challenges, underscoring a need for enhanced due diligence, transparent disclosures, realistic valuations of AI assets, and verifiable evidence of the technology’s efficacy.

 

Briana C. Breault is an associate attorney in the Litigation and Bankruptcy Departments at the law firm of Coolidge Wall Co., L.P.A. in Dayton, Ohio. With a background in bankruptcy law, Briana primarily focuses her practice on creditor rights, insolvency, and commercial litigation. Prior to joining Coolidge Wall, Briana worked as a Law Clerk for the Honorable Guy R. Humphrey in the U.S. Bankruptcy Court, Southern District of Ohio.

 

Endnotes

1 Yazhou Sun, Mark Bergen, and Newley Purnell, Builder.ai Faked

Business With Indian Firm VerSe to Inflate Sales, Sources Say,

Bloomberg (last updated May, 31, 2025 at 12:47 PM), https://

www.bloomberg.com/news/articles/2025-05-30/builder-aifaked-

business-with-indian-firm-verse-to-inflate-sales-sourcessay?

embedded-checkout=true.

2 Id.; Petition, In re Engineer.ai Corp., No. 25-10984-CTG (Bankr. Del.

Jun. 2, 2025), Dkt. No. 1.

3 Jonathan D. Uslaner and Alec Coquin, ‘AI washing’: regulatory and

private actions to stop overstating claims, Reuters (last updated May

30, 2025), https://www.reuters.com/legal/legalindustry/ai-washingregulatory-

private-actions-stop-overstating-claims-2025-05-30/

4 Newley Purnell and Parmy Olson, AI Startup Boom Raises Questions

of Exaggerated Tech Savvy, The Wall Street Journal (Aug.

14, 2019), https://www.wsj.com/articles/ai-startup-boom-raisesquestions-

of-exaggerated-tech-savvy-11565775004.

5 Ryniker v. Wash. (In re Augustus Intelligence Inc.), Nos. Case No.

21-10744 (TMH), 23-50370 (TMH), 2025 Bankr. LEXIS 707, at *4

(Bankr. D. Del. Mar. 26, 2025)

6 Id.

7 Id. at *5.

8 Id. at *6.

9 Id. at *6-7.

10 Id. at *8.

11 Id.