The ATP-dependent protease FtsH (HflB) complexed with HflKC participates in post-translational control of the lysis-lysogeny decision of bacteriophage lambda by rapid degradation of lambda CII. Both phage-encoded proteins, the CII transcription activator and the CIII polypeptide, are required for efficient lysogenic response. The conserved CIII is both an inhibitor and substrate of FtsH. Here we show that the protease inhibitor CIII is present as oligomeric amphipathic alpha helical structures and functions as a competitive inhibitor of FtsH by preventing binding of the CII substrate. We identified single alanine substitutions in CIII that abolish its activity. We characterize a dominant negative effect of a CIII mutant. Thus, we suggest that CIII oligomrization is required for its function. Real-time analysis of CII activity demonstrates that the effect of CIII is not seen in the absence of either FtsH or HflKC. When CIII is provided ectopically, CII activity increases linearly as a function of the multiplicity of infection, suggesting that CIII enhances CII stability and the lysogenic response. FtsH function is essential for cellular viability as it regulates the balance in the synthesis of phospholipids and lipopolysaccharides. Genetic experiments confirmed that the CIII bacteriostatic effects are due to inhibition of FtsH. Thus, the early presence of CIII following infection stimulates the lysogenic response, while its degradation at later times ensures the reactivation of FtsH allowing the growth of the established lysogenic cell.