Yemen's president and the country's top general are hashing out a settlement in which both men would resign within days, people familiar with the situation said, raising crucial questions of who will end up leading a key, though embattled, U.S. counterterrorism ally.

The outlines of a peaceful transition, to a civilian-led transitional government, emerged amid rising tension over the standoff between Yemeni President Ali Abdullah Saleh and pro-democracy protesters backed by Gen. Ali Mohsen al-Ahmar....