Liver development is based on reciprocal interactions between ventral foregut endoderm and adjacent mesenchymal tissues. Targeted disruption of the LIM-homeobox gene Lhx2 has revealed that it is important for the expansion of the liver during embryonic development, whereas it appears not to be involved in the induction of hepatic fate. It is not known whether Lhx2 is expressed in the endodermal or mesenchymal portion of the liver, or if the cells normally expressing Lhx2 are absent or present in the liver of Lhx2(-/-) embryos. To address this we have analyzed gene expression from the Lhx2 locus during hepatic development in wild type and Lhx2(-/-) mice. Lhx2 is expressed in cells of the septum transversum mesenchyme adjacent to the liver bud from embryonic day 9. The hepatic cords subsequently migrate into and intermingle with the Lhx2+ cells of the septum transversum mesenchyme. Lhx2 expression is thereafter maintained in a subpopulation of mesenchymal cells in the liver until adult life. In adult liver the Lhx2+ mesenchymal cells co-express desmin, a marker associated with stellate cells. At embryonic day 10.5, cells expressing the mutant Lhx2 allel are present in Lhx2(-/-) livers, and expression of Hlx, hepatocyte growth factor, Hex and Prox1, genes known to be important in liver development, is independent of functional Lhx2 expression. Thus, Lhx2 is specifically expressed in the liver-associated septum transversum mesenchyme that subsequently becomes an integral part of the liver and the formation of these mesenchymal cells does not require functional Lhx2.