The Hedgehog pathway transcription factor Gli1 induces transformation of epithelial cells via induction of Snail, a repressor of E-cadherin (E-cad). E-cad is normally complexed with β-catenin at the cell membrane. Loss of E-cad during developmental epithelial–mesenchymal transitions can switch β-catenin from its role at adherens junctions to its role in nuclear transcription. During tumorigenesis it is unclear which pathways trigger this switch. In the current study, gain-and loss-of-function approaches identified E-cad as a selective inhibitor of transformation by Gli1, and Snail knockdown was rescued by downregulation of E-cad. Gli1 induced relocalization of β-catenin from the cell membrane to the nucleus. The ability of wild-type or mutant alleles of E-cad to modulate transformation by Gli1 correlated with their ability to regulate localization of β-catenin. Inhibition of Wnt-β-catenin signaling by dominant negative Tcf4 selectively blocked in vitro transformation by Gli1. In Gli1-transgenic mice, infiltrating skin tumor cells expressed active, unphosphorylated β-catenin. Our studies identify E-cad as a selective suppressor of transformation by Gli1 and point to the Sonic Hedgehog–Gli1 pathway as a key regulator of the β-catenin switch in epithelial cells and cancers.