* Western Digital would tie up with KKR, state funds -sources
* Western Digital seeking 15 pct stake -sources
* Toshiba chip execs wary of Western Digital deal -sources (Recasts with sources saying Toshiba focusing on talks with Western Digital)
By Taro Fuse
TOKYO, Aug 23 (Reuters) - Japan's Toshiba Corp is prioritising negotiations with Western Digital to sell its memory chip business after talks stalled with a previously preferred bidder, sources familiar with the matter said on Wednesday.
The conglomerate is scrambling to sell its flash memory unit to cover losses from its bankrupt U.S. nuclear business Westinghouse.
In June, it picked a consortium including Japanese government-backed funds, private equity firm Bain Capital and South Korean chip maker SK Hynix as the preferred bidder for the prized unit.
But the talks stalled after Western Digital, a partner in Toshiba's main chip plant, took Toshiba to court, arguing it needs to consent to a sale. A subsequent legal battle between the two companies unnerved the state-backed funds, which demanded Toshiba resolve the conflict before a sale.
Western Digital was offering around 2 trillion yen ($18 billion) and plans to form an alliance with U.S. private equity firm KKR & Co as well as the two Japanese state-backed funds that were part of the preferred bidder group, sources said, adding Western Digital was likely to take a stake of around 15 percent in the chip business.
The other consortium including Bain and SK Hynix lost its preferred status at the end of July, the sources added, requesting anonymity because they were not authorised to speak with media.
A Toshiba spokesman declined to comment on details of the negotiations.
Toshiba wants to close the sale by the end of the fiscal year in March to ensure it does not report negative net worth, or liabilities exceeding assets, for a second year running. This could result in a delisting from the Tokyo Stock Exchange.
Given regulatory approvals could take more than six months, the company has been hoping to reach a deal by the end of the month to ensure it can close the sale in time.
Sources have also said a deal with Western Digital could be difficult, however, as Toshiba's chip business executives were wary of a deal with the U.S. company given previous animosity between the two sides.
Ties between the two companies soured quickly after Western Digital bought SanDisk, Toshiba's memory chip business partner for 17 years, in May last year as they failed to agree on terms of a new joint venture contract. ($1 = 109.6700 yen) (Additional reporting by Makiko Yamazaki; Writing by Ritsuko Ando; Editing by Muralikumar Anantharaman and David Holmes)