In the unfolded protein response (UPR) signaling pathway, accumulation of unfolded proteins in the endoplasmic reticulum (ER) activates a transmembrane kinase/ribonuclease Ire1, which causes the transcriptional induction of ER-resident chaperones, including BiP/Kar2. It was previously hypothesized that BiP/Kar2 plays a direct role in the signaling mechanism. In this model, association of BiP/Kar2 with Ire1 represses the UPR pathway while under conditions of ER stress, BiP/Kar2 dissociation leads to activation. To test this model, we analyzed five temperature-sensitive alleles of the yeast KAR2 gene. When cells carrying a mutation in the Kar2 substrate-binding domain were incubated at the restrictive temperature, association of Kar2 to Ire1 was disrupted, and the UPR pathway was activated even in the absence of extrinsic ER stress. Conversely, cells carrying a mutation in the Kar2 ATPase domain, in which Kar2 poorly dissociated from Ire1 even in the presence of tunicamycin, a potent inducer of ER stress, were unable to activate the pathway. Our findings provide strong evidence in support of BiP/Kar2-dependent Ire1 regulation model and suggest that Ire1 associates with Kar2 as a chaperone substrate. We speculate that recognition of unfolded proteins is based on their competition with Ire1 for binding with BiP/Kar2.