Adenomatous polyposis coli protein (APC) is an important tumour suppressor in the human colon epithelium. In a complex with glycogen synthase kinase-3 (GSK-3), APC binds to and destabilizes cytoplasmic ('free') beta-catenin. Here, using a yeast two-hybrid screen for proteins that bind to the Drosophila beta-catenin homologue, Armadillo, we identify a new Drosophila APC homologue, E-APC. E-APC also binds to Shaggy, the Drosophila GSK-3 homologue. Interference with E-APC function produces embryonic phenotypes like those of shaggy mutants. Interestingly, E-APC is concentrated in apicolateral adhesive zones of epithelial cells, along with Armadillo and E-cadherin, which are both integral components of the adherens junctions in these zones. Various mutant conditions that cause dissociation of E-APC from these zones also obliterate the segmental modulation of free Armadillo levels that is normally induced by Wingless signalling. We propose that the Armadillo-destabilizing protein complex, consisting of E-APC, Shaggy, and a third protein, Axin, is anchored in adhesive zones, and that Wingless signalling may inhibit the activity of this complex by causing dissociation of E-APC from these zones.