Mutations in the DELTA-LIKE 3 (DLL3) gene cause the congenital abnormal vertebral segmentation syndrome, spondylocostal dysostosis (SCD). DLL3 is a divergent member of the DSL family of Notch ligands that does not activate signalling in adjacent cells, but instead inhibits signalling when expressed in the same cell as the Notch receptor. Targeted deletion of Dll3 in the mouse causes a developmental defect in somite segmentation, and consequently vertebral formation is severely disrupted, closely resembling human SCD. In contrast to the canonical Notch signalling pathway, very little is known about the mechanism of cis-inhibition by DSL ligands. Here, we report that Dll3 is not presented on the surface of presomitic mesoderm (PSM) cells in vivo, but instead interacts with Notch1 in the late endocytic compartment. This suggests for the first time a mechanism for Dll3-mediated cis-inhibition of Notch signalling, with Dll3 targeting newly synthesized Notch1 for lysosomal degradation prior to post-translational processing and cell surface presentation of the receptor. An inhibitory role for Dll3 in vivo is further supported by the juxtaposition of Dll3 protein and Notch1 signalling in the PSM. Defining a mechanism for cis-inhibition of Notch signalling by Dll3 not only contributes greatly to our understanding of this ligand's function during the formation of the vertebral column, but also provides a paradigm for understanding how other ligands of Notch cis-inhibit signalling.