N-hydroxyphthalimide (NHPI), which is best known as an organocatalyst for efficient C-H activation, has been found to be oxidized by quinoid compounds to its corresponding catalytically active nitroxide-radical. Here, we found that NHPI can be isomerized into isatoic anhydride by an unusually facile two-step method using tetrachloro-1,4-benzoquinone (TCBQ, p-chloranil), accompanied by a two-step hydrolytic dechlorination of highly toxic TCBQ into the much less toxic dihydroxylation product, 2,5-dichloro-3,6-dihydroxy-1,4-benzoquinone (chloranilic acid). Interestingly, through the complementary application of oxygen-18 isotope-labeling, HPLC combined with electrospray ionization quadrupole time-of-flight and high resolution Fourier transform ion cyclotron resonance mass spectrometric studies, we determined that water was the source and origin of oxygen for isatoic anhydride. Based on these data, we proposed that nucleophilic attack with a subsequent water-assisted Lossen rearrangement coupled with rapid intramolecular addition and cyclization in two consecutive steps was responsible for this unusual structural isomerization of NHPI and concurrent hydroxylation/detoxication of TCBQ. This is the first report of an exceptionally facile double-isomerization of NHPI via an unprecedented water-assisted double-Lossen rearrangement under normal physiological conditions. Our findings may have broad implications for future research on hydroxamic acids and polyhalogenated quinoid carcinogens, two important classes of compounds of major chemical and biological interest.