This study is to investigate the viability of hepatocytes when transplanted into Wistar rats using co-encapsulated hepatocytes and bone marrow stem cells. Hepatocytes and bone marrow stem cells, isolated from Wistar rats, are co-encapsulated using either the standard single-step method or a novel two-step cell encapsulation method (www.artcell.mcgill.ca). After intraperitoneal transplantation into Wistar rats, the histology, fate of recovered microcapsules and viability of encapsulated hepatocytes are studied. When prepared using the standard method, there is excellent viability but only for up to 3 weeks. After this, there is extensive fibrous coating and severe fibrous adhesion and no microcapsules can be recovered. On the other hand, using the new two-step encapsulation method, the viability of the encapsulated hepatocytes can be followed for more than 4 months after transplantation. Even up to 4 months, there is significantly less host reaction when using the two-step encapsulation method and 50% of the microcapsules can be recovered. Co-encapsulated with bone marrow stem cells resulted in further increase in viability of the hepatocytes when followed up to 4 months after transplantation. This new approach may improve the potential feasibility of using co-encapsulation of hepatocytes and bone marrow stem cells in bio-artificial liver support for the treatment of liver failure, especially for acute liver failure.