The integration of artificial intelligence (AI) in mental healthcare offers innovative solutions for diagnosis, treatment, and patient support. However, these advancements introduce legal and ethical challenges where existing regulatory frameworks, often, fall short in addressing the unique implications of AI in mental health contexts. This paper examines these regulatory gaps and ethical dilemmas while presenting specific AI tools currently deployed in mental healthcare, such as IBM Watson for mental health analysis, and Wysa for cognitive behavioral therapy (CBT), for early detection of mental health conditions. Additionally, the paper explores regulatory proposals aimed at addressing these challenges, including amendments to HIPAA, GDPR, and emerging AI ethics guidelines. The discussion expands on privacy mechanisms, algorithmic bias, and the impact of AI-driven tools on various stakeholders, including patients, healthcare providers, and insurers. The study also highlights AI’s effects on patient autonomy and consent, particularly in cases where cognitive impairment may limit informed decision-making. By linking findings with existing literature, this paper offers recommendations for interdisciplinary collaboration and ethical foresight in AI-driven mental healthcare, ensuring a balance between technological innovation and the protection of patient rights.