Hepatocyte growth factor activator inhibitor-1 (HAI-1) is a Kunitz-type transmembrane serine protease inhibitor that forms inhibitor complexes with several trypsin-like serine proteases and is required for mouse placental development and embryo survival. Here we show that the essential function of HAI-1 in placentation and all other embryonic processes is to restrict the activity of the type II transmembrane serine protease, matriptase. Enzymatic gene trapping of matriptase combined with HAI-1 immunohistochemistry revealed that matriptase is co-expressed with HAI-1 in both extraembryonic and embryonic tissues. As early as embryonic day 8.5, matriptase and HAI-1 were expressed in a population of chorionic trophoblasts. Ablation of HAI-1 disrupted the epithelial integrity of this cell population, causing disorganized laminin deposition and altered expression of E-cadherin and beta-catenin. This led to a complete loss of undifferentiated chorionic trophoblasts after embryonic day 9.5 and prevented the formation of the placental labyrinth. Genetic ablation of matriptase activity in HAI-1-deficient embryos, however, restored the integrity of chorionic trophoblasts and enabled placental labyrinth formation and development to term. Furthermore, matriptase/HAI-1 double-deficient mice were phenotypically indistinguishable from matriptase single-deficient littermates.