Background: Many intracellular signal-transduction pathways are regulated by specific protein-protein interactions. These interactions are mediated by structural domains within signaling proteins that modulate a protein's cellular location, stability or activity. For example, Src-homology 2 (SH2) domains mediate protein-protein interactions through short contiguous amino acid motifs containing phosphotyrosine. As SH2 domains have been recognized as key regulatory molecules in a variety of cellular processes, they have become attractive drug targets. Results: We have developed a novel mechanism-based cellular assay to monitor specific SH2-domain-dependent protein-protein interactions. The assay is based on a two-hybrid system adapted to function in mammalian cells where the SH2 domain ligand is phosphorylated, and binding to a specific SH2 domain can be induced and easily monitored. As examples, we have generated a series of mammalian cell lines that can be used to monitor SH2-domain-dependent activity of the signaling proteins ZAP-70 and Src. We are utilizing these cell lines to screen for immunosuppressive and anti-osteoclastic compounds, respectively, and demonstrate here the utility of this system for the identification of small-molecule, cell-permeant SH2 domain inhibitors. Conclusions: A mechanism-based mammalian cell assay has been developed to identify inhibitors of SH2-domain-dependent protein-protein interactions. Mechanism-based assays similar to that described here might have general use as screens for cell-permeant, nontoxic inhibitors of protein-protein interactions.