Anyone know how to create characters which sit or lay on furniture?

I'm not sure it's possible, since the game engine doesn't have an animation at all for sitting. But if you're talking about a character that is permanently seated, you could just make the model in the seated position and set the AI not to move.

Here is a mod that offers sitting NPCs. I have not tried it myself, but I heard it is somewhat poorly done.

well, if you have 3d studio you can make some new aminations, although...its incredibally hard to animate, since i just made a dolphin jump through a loop last night, it took me all night to get done, and half of it was screwed up.
so, if you intend to animate it, good luck, youll need it

What I mean is there's no animation in the game engine. The game just doesn't have any spot for "if npc comes within sitting disance of a chair", so there would be nothing to tell it to use the animation.

but you can put that in the game cant you, because ive noticed, you can see the animation names.

Right, you could make an animation of a person sitting and attach it to some other animation slot (swinging a sword, for example). But what you can't do is get the context right and get a person to sit at the right time and in the right place. The game engine just doesn't have something like "when distancetochair = 0, play animation 'sit' and don't move".

So adding sitting/laying/etc to the game would require an extreme amount of work and require creating new animations? Sounds like an good team project to me.