Eph receptor-ephrin signals are important for controlling repulsive and attractive cell movements during tissue patterning in embryonic development. However, the dynamic cellular responses to these signals at cell-cell contact sites are poorly understood. To examine these events we have used cell microinjection to express EphB4 and ephrinB2 in adjacent Swiss 3T3 fibroblasts and have studied the interaction of the injected cells using time-lapse microscopy. We show that Eph receptors are locally activated wherever neighbouring cells make contact. This triggers dynamic, Rac-regulated membrane ruffles at the Eph-ephrin contact sites. Subsequently, the receptor and ligand cells retract from one another, concomitantly with the endocytosis of the activated Eph receptors and their bound, full-length ephrinB ligands. Both the internalization of the receptor-ligand complexes and the subsequent cell retraction events are dependent on actin polymerization, which in turn is dependent on Rac signalling within the receptor-expressing cells. Similar events occur in primary human endothelial cells. Our findings suggest a novel mechanism for cell repulsion, in which the contact between Eph-expressing and ephrin-expressing cells is destabilized by the localized phagocytosis of the ligand-expressing cell plasma membrane by the receptor-expressing cell.