Lili and Sebation teleported to the Digital World...
Think about it, in Street Fighter vs Tekken we are introduced to a few other characters from different franchises such as Megaman, Pacman and Sam. So logically a portal from a different dimension(s) appeared and happened to suck up Lili and Sebation (and maybe that also exlains Lars being in Naruto, but however he is in SVT game).
