TOKYO (Reuters) - Western Digital Corp WDC.O has sought international arbitration to stop partner Toshiba Corp 6502.T from selling its chips arm without its consent, potentially derailing a much-needed capital injection for the Japanese conglomerate.

The two companies jointly operate Toshiba’s main semiconductor plant but Western Digital is not a favored bidder for the world’s second biggest NAND chip producer, having put in a much lower offer than other suitors, a source with knowledge of the matter has said.

A legal battle could delay or put an end to an auction that could fetch some $18 billion and has attracted suitors such as private equity firm KKR & Co LP KKR.N, Taiwan's Foxconn 2317.TW and U.S. chipmaker Broadcom AVGO.O.

Toshiba is depending on the sale to cover billions in dollars in cost overruns at its now bankrupt U.S. nuclear unit Westinghouse. The Japanese firm logged a 950 billion yen ($8.4 billion) annual net loss and had negative shareholder equity of 540 billion yen, it said in an unaudited earnings release on Monday.

After months of souring relations, Western Digital has begun arbitration procedures with the International Chamber of Commerce, demanding Toshiba reverse a move to put their joint venture assets into a newly formed unit - Toshiba Memory - and stop any sale without Western Digital’ s consent.

Western Digital’s “efforts to achieve a resolution to date have been unsuccessful, and so we believe legal action is now a necessary next step,” CEO Steve Milligan said in a statement.

Toshiba CEO Satoshi Tsunakawa told a news conference the complaint was groundless and that Toshiba would push on with the sale, sticking to its plan to complete the second round of bidding on Friday.

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“We will make efforts to convince bidders of the legitimacy of the chip-unit sale and wipe away their concerns,” he said.

Toshiba argues neither party can block a change of control by the other partner. It says Western Digital itself acquired the joint venture interest when it bought current unit SanDisk, and never sought or received Toshiba’s approval.

But Western Digital counters that the contract only allows Toshiba not to seek approval if the Japanese company is acquired by a third party.

LISTING, FINANCING AT STAKE

The escalating dispute could also further jeopardize Toshiba’s Tokyo bourse listing as fresh funds are urgently needed to shore up its balance sheet, as well as upend financing plans. Toshiba hopes to offer a stake in the chip unit as collateral for new loans from major lenders, a measure that the banks say also requires Western Digital’s approval.

Toshiba believes that a consortium made up of KKR and Japanese government-backed investors would be the most feasible buyer for the business, sources with direct knowledge said last week.

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The Japanese government has proposed that Western Digital join their consortium as a minority investor, but the California-based firm has said it needs to take control of the unit in order to be fully in charge of operations, separate sources have said.

Toshiba’s Tsunakawa said the company would make a decision on Tuesday whether to proceed with a threat it made this month to block Western Digital employees from the plant as well as databases if the U.S. company did not sign a broad collaboration agreement that the two had negotiated.

Toshiba has said any move would not affect joint venture operations because it does not apply to SanDisk employees.

Despite the fresh setback, Toshiba shares climbed 3.4 percent, buoyed by news that progress is being made toward capping some of its nuclear liabilities in the United States - another major headache.

The owners of the unfinished Vogtle power plant in Georgia led by Southern Co SO.N have to come to a preliminary agreement to cap Toshiba's responsibility for its guarantees on the project at about $3.6 billion, people familiar with the matter said on Sunday.

“The stock seems to be rallying on the perception it will avoid delisting which is a risky assumption to make,” said CLSA analyst Claudio Aritomi.

All of Toshiba's bonds are trading below par, including 30 billion yen in debt maturing on July 26. The cost of insuring against default on Toshiba's five-year yen debt in the market for credit default swaps TOSB5YJPAC=MG was indicated 8 basis points higher at 388/418 basis points.

($1 = 113.3 yen)