The neurofibromatosis type 2 (NF2) tumor suppressor, Merlin, is a membrane/cytoskeleton-associated protein that mediates contact-dependent inhibition of proliferation. Here we show that upon cell-cell contact Merlin coordinates the processes of adherens junction stabilization and negative regulation of epidermal growth factor receptor (EGFR) signaling by restraining the EGFR into a membrane compartment from which it can neither signal nor be internalized. In confluent Nf2(-/-) cells, EGFR activation persists, driving continued proliferation that is halted by specific EGFR inhibitors. These studies define a new mechanism of tumor suppression, provide mechanistic insight into the poorly understood phenomenon of contact-dependent inhibition of proliferation, and suggest a therapeutic strategy for NF2-mutant tumors.