* SK Hynix part of preferred bidder consortium
* Toshiba has said SK Hynix will not have equity in chip unit
* Japan wants to block foreign rivals gaining key chip technology (Adds comments from sources, Toshiba court filing in U.S.)
SEOUL/TOKYO, July 3 (Reuters) - SK Hynix Inc has proposed that its financing for a consortium picked as preferred bidder for Toshiba Corp's chip unit be done via convertible bonds, two sources said, providing it with a path towards an equity interest in the world's No.2 NAND chip maker.
But such an arrangement would fly in the face of Toshiba's assertions that its South Korean rival will have no equity or management influence in the $18 billion chip unit - a stance it has taken to satisfy a government that wants the business to remain under domestic control and for key technology to be kept out of the hands of foreign rivals.
The potential for SK Hynix to hold equity would also only harden already trenchant opposition from Western Digital , Toshiba's chip business partner, which is claiming breach of contract and seeking to an injunction to prevent any deal that does not have its consent.
The South Korean chipmaker is part of a Japan government-led consortium that also includes Bain Capital and which was hastily cobbled together last month by Japan's trade ministry. While it has the government's implicit stamp of approval, the unusual structure of the offer has raised questions over whether can feasibly clinch a deal.
"New details coming out through the media such as the convertible bonds suggest there may be some flaws in the scheme. Toshiba must now explain its exact structure," said Masahiko Ishino, an analyst at Tokai Tokyo Research Center.
"Reaching a deal is now looking difficult," he added.
Sources familiar with the matter have said a state-backed fund, the Innovation Network Corp of Japan (INCJ), would hold the biggest equity interest despite putting up only 300 billion yen ($2.7 billion) of the planned 2 trillion yen.
Bain plans to put up 850 billion yen - half of that amount to be provided by SK Hynix in the form of financing, the sources have said.
The South Korean chipmaker plans to buy convertible debt in a special purpose company being created by Bain for the Toshiba acquisition, said one of the sources who spoke on Monday, adding that terms were still being negotiated.
SK Hynix was unlikely to convert the debt into equity in the near term, the source said.
SK Hynix declined to comment while representatives for Bain could not be immediately reached for comment. A Toshiba spokesman said the company cannot comment on the specifics of the deal. The sources declined to be identified as the talks were confidential.
Toshiba is scrambling to get a deal done as fast as possible as it needs funds to cover billions in cost overruns at now-bankrupt unit Westinghouse.
But last week, the Japanese conglomerate missed a self-imposed deadline of having a signed agreement for the chip business in hand, saying more time was needed to smooth out opinions between members of the preferred bidder consortium.
Officials within Toshiba's board and INCJ are also concerned about the potential for technology leaks and are demanding the final contract specify that the South Korean firm's financing will never be translated into equity, separate sources have said.
SK Hynix has only briefly explained its rationale for being part of the consortium, saying that it sees further business opportunities with Toshiba. It is relatively weak in NAND memory chips although it is the world's No. 2 maker of DRAM chips, which help electronic devices multitask.
Toshiba said separately it had made a filing outlining its arguments to Western Digital's request for a preliminary injunction to block the sale of the chip business sale. A hearing on the issue is scheduled for July 14 and Western Digital has said it believes a decision will come on the same day.
($1 = 112.6500 yen) (Reporting by Se Young Lee and Kentaro Hamada; Additional reporting by Makiko Yamazaki and Junko Fujita in Tokyo and Joyce Lee in Seoul; Editing by Edwina Gibbs)