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UPDATE 3-UK, France closer on EADS-BAE merger as deadline nears

* Sources say UK, France propose broad state voting cap

* Idea would allow states to raise stakes if ceiling intact

* Germany said to maintain demand for parity with France

* EADS, BAE boards meet to decide whether to seek more time

* UK deadline for deal expires on Wednesday

(Adds French minister) By Tim Hepher and Chris Vellacott

PARIS/LONDON, Oct 9 (Reuters) - France and Britain made a breakthrough over state shares in a merger between EADS and BAE Systems, making an extension of a deadline for negotiations more likely but putting the two nations on a collision course with Germany.

With a 1600 GMT deadline on Wednesday fast approaching, both companies' boards were set to decide whether to keep their merger hopes alive by seeking a roughly two-week extension to complete their dramatic obstacle course to a deal.

The decision is a critical one for Tom Enders, the head of EADS and BAE counterpart Ian King, who have staked their companies' reputations on realising a decade-old plan for a global aerospace and defence giant based in Europe.

"Ian King and Tom Enders will discuss the situation later today and then decide, jointly with the respective company boards, the way forward," EADS said in an emailed statement.

In an important change of tone after days of tense talks, sources familiar with the matter said France and Britain had significantly narrowed differences over the wording of guarantees on state shareholdings in the $45 billion merger.

French Defence Minister Jean-Yves le Drian said on the sidelines of a meeting of NATO defence ministers in Brussels that negotiations on the merger had moved forward.

"We had made a lot of progress, I think, but have we progressed enough? That is up to those who initiated the project to say," the minister said.

Yet doubts emerged almost immediately over whether Germany - the other half of the Airbus parent group forged together with France in 2000 - would back the proposal.

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The idea hammered out in three days of talks is to allow France to increase its stake but only if an overall ceiling on state shareholdings in the new aerospace group was respected.

The BAE board meeting started at 1500 GMT, sources close to the negotiations said. One source said BAE was still hopeful that the companies would request an extension on Wednesday.

U.S. CONCERNS

Sources said this should not be much more than 18 percent in order to win backing from BAE, which wants to protect its large U.S. defence business from any disruptive new regulation stemming from U.S. concerns about foreign government control.

But this would mark a departure from a system of power-sharing between France and Germany or their industrial allies in EADS and risks rekindling years of cross-border mistrust.

"For this to work, it would mean breaking the link between the potential future size of the French shareholding and the German one," a diplomatic source following the talks said.

France has so far insisted on the right to acquire more than 10 percent of the new group, compared with the 9 percent it would automatically end up with under proposed merger terms.

Germany wants parity with France, and a senior negotiating source said the German position was unchanged and that Berlin remained far from impressed with progress.

"The situation looks dark for the merger since there is still no consensus between the governments," the source said, adding the companies could decide to call the merger off.

EADS denied a German news agency report that talks had collapsed and confirmed progress in the UK-French negotiations.

"We are surprised to see the reports from Berlin. Only this morning, we have received the information that France and the UK have made significant progress on the issue that was blocking the negotiations for the last few days," an EADS spokesman said.

"The two companies will discuss the situation and possible steps forward this afternoon."

"NOTICEABLY CLOSER"

The approaches of the French, British and German governments at the start of the talks were different, the French minister said. "They have moved noticeably closer together but have they moved closed enough for the companies to think it is worth (asking for) an extension? That is up to them to say," he said.

EADS has put its unions on stand-by for briefings on a possible deal in either one week or two weeks, union officials said, suggesting the companies would seek a far shorter extension that the maximum allowed 28 days. A scheduled European works council went ahead on Tuesday with no managers present.

The mention of "significant progress", the most upbeat comments by EADS since merger talks emerged last month, appeared to meet the criteria for an extension in the UK deadline, but Enders and King still brandish it as a negotiating tool.

The companies have insisted they will only request an extension to the Oct. 10 deadline set by UK regulators if there is meaningful progress at government level.

A French government source said the country had not changed its official opposition to a 10 percent cap on its future shareholding in the group, which would be the world's largest aerospace and arms conglomerate with 220,000 employees.

Underscoring doubts among investors, shares in EADS rose sharply on the reported failure, then fell back to mark time awaiting the decision from top management assembled in Toulouse.

The companies say they cannot spell out the full benefits of the merger before completing negotiations over the shape of the company's capital and possible guarantees on investment.

"The first thing they will have to do is get an extension and then the communication from the company has to improve," said one of the top BAE shareholders, asking not to be named.

"They have to get on the road and convince investors why this is a good thing. I don't think just placating the governments is going to work any more now."

Britain and France have the power to veto the deal, which must also be approved by the United States and overcome political objections in Germany. France owns 15 percent of EADS which would be diluted to 9 percent of the new group. Germany is not a direct shareholder.

Core EADS shareholders Lagardere , the French media firm, and German car firm Daimler also have the right to veto a deal. Both have expressed unease about the terms but are not participating in board discussions to prevent a conflict of interest, according to a person familiar with the talks.

(Additional reporting by Gernot Heller, Mathias Blamont, Sophie Sassard, Paul Sandle, Chris Vellacott, Arno Schuetze, Elizabeth Pineau, Andreas Rinke, Adrian Croft, Sebastian Moffett, Mohammed Abbas, Julien Ponthus, Jason Neely, Blaise Robinson, Simon Jessop, James Regan, editing by Peter Millership)

((tim.hepher@thomsonreuters.com)(+33 1 49 49 54 52)(Reuters Messaging: tim.hepher.thomsonreuters@reuters.net))

Keywords: EADS BAE/