The development of our internal organs is coordinated by complex interactions between the mesothelium, epithelium and mesenchyme. The mesothelium is a squamous monolayer layer that ensheathes our internal organs. It serves as a protective barrier and secretes lubricants to facilitate organ movement against each other and the body wall. However, how it forms is poorly understood. We were prompted to investigate Myrf, a transcription factor gene expressed in the mesothelium, because it carries variants in Congenital Diaphragmatic Hernia (CDH) patients. Here we show that in mice, inactivation of Myrf at the start of lung development resulted in CDH and defective mesothelium specification, compromising its function as a signaling center for lung growth. Inactivation of Myrf at a later stage led to partial epithelium-to-mesenchyme transition (EMT) of the mesothelium into cells with smooth muscle characteristics. In this role, MYRF functions in parallel with the Hippo pathway to control mesothelial cell differentiation. Together, these findings establish Myrf as a critical regulator of mesothelium cell fate, and when mutated, causes CDH.