* Peugeot reaches outline deal with Dongfeng, France -sources
* Talks continue over chairman nomination -sources
* Memorandum of understanding to be finalised Feb. 18 -sources (Adds details, background)
By Sophie Sassard, Laurence Frost and Gilles Guillaume
PARIS, Feb 12 PSA Peugeot Citroen has reached an outline deal with Dongfeng and France to raise up to 4 billion euros ($5.5 billion) in fresh capital and deepen cooperation with the Chinese carmaker, sources familiar with the matter said.
The agreement is due to be presented to the Peugeot board on Feb. 18 and likely signed as a non-binding memorandum of understanding the same day, according to three sources with direct knowledge of the situation.
Peugeot, battered by Europe's prolonged auto demand slump and sustained by 7 billion euros of state guarantees, needs a cash infusion to stay afloat. The planned share sale to Dongfeng and the French government may be its last survival hope after the failure of earlier deal talks with U.S.-based General Motors .
The accompanying industrial plan would see Peugeot and Dongfeng retain and expand their existing joint venture, increasing research and development cooperation with a view to expanding into South East Asian markets, according to the sources, who declined to be named because the talks were confidential.
Peugeot has been in talks with Dongfeng for months over a rescue plan that would see the Chinese automaker and French government take matching stakes of about 14 percent each.
With most details now agreed - including a heavily discounted 7.50 euro issue price for the two new shareholders - the choice of a new independent chairman is the main outstanding point to be resolved, several sources said. Peugeot shares closed at 12.52 euros on Wednesday.
The French government is pushing Louis Gallois, a senior civil servant who joined the Peugeot board on a nominally independent ticket as a condition of the existing state guarantee in place since 2012, the sources said.
But Dongfeng is resisting his nomination and rooting instead for prominent French businesswoman Patricia Barbizet, another independent Peugeot director.
A spokeswoman for Barbizet did not immediately return calls seeking comment. Peugeot declined to comment on the deal talks with Dongfeng. Representatives of Wuhan, China-based Dongfeng could not be reached.
Under the terms, to be announced with its full-year results next week, Peugeot will raise 3 billion euros through the reserved share sale to Dongfeng and the French government and through a smaller, subsequent rights issue to existing shareholders.
Current shareholders will also receive warrants to purchase additional stock at an equivalent price in an operation that may raise as much as 1 billion euros more, one source said.
French deal negotiators returned this week from China after a final round of substantive talks with state-owned Dongfeng, he said.
The French carmaker said on Jan. 20 it was engaged in discussions on a deeper Dongfeng partnership backed by a 3 billion euro capital increase and warrants issue.
Trading in Dongfeng shares was briefly suspended on Monday as the Chinese carmaker also confirmed the talks in a statement.
($1 = 0.7312 euros) (Reporting by Sophie Sassard, Laurence Frost and Gilles Guillaume; editing by Keiron Henderson and Andrew Callus)