Proteasomes are essential for protein homeostasis in eukaryotes. To preserve cellular function, transcription of proteasome subunit genes is induced in response to proteasome dysfunction caused by pathogen attacks or proteasome inhibitor drugs. In Caenorhabditis elegans, this response requires SKN-1, a transcription factor related to mammalian Nrf1/2. Here, we use comprehensive genetic analyses to identify the pathway required for C. elegans to detect proteasome dysfunction and activate SKN-1. Genes required for SKN-1 activation encode regulators of ER traffic, a peptide N-glycanase, and DDI-1, a conserved aspartic protease. DDI-1 expression is induced by proteasome dysfunction, and we show that DDI-1 is required to cleave and activate an ER-associated isoform of SKN-1. Mammalian Nrf1 is also ER-associated and subject to proteolytic cleavage, suggesting a conserved mechanism of proteasome surveillance. Targeting mammalian DDI1 protease could mitigate effects of proteasome dysfunction in aging and protein aggregation disorders, or increase effectiveness of proteasome inhibitor cancer chemotherapies. DOI: http://dx.doi.org/10.7554/eLife.17721.001