Two main shareholders of loss-making insurer Fondiaria-SAI on Friday rejected a key condition of a planned merger with smaller peer Unipol , throwing into disarray a complicated plan to create Italy's No. 2 insurer.

Adding to the complexity of the situation, Italian private equity funds Sator of banker Matteo Arpe and Palladio Finaziaria rejigged a rival offer for Fondiaria which sees its rescue through a capital increase of no less than 800 million euros ($1 billion).

The rescue of Fondiaria, Italy's biggest car insurer, is crucial to top Italian investment house Mediobanca, which is exposed to Fondiaria through 1.1 billion euros of loans.

In January, Mediobanca brokered a deal in which Unipol, Italy's No. 3 insurer, agreed to rescue Fondiaria through a four-way merger and a series of capital increases.

But the plan came under regulatory scrutiny after hitting several snags.

Unipol, which had previously offered the Ligresti family an amnesty against future legal action, was forced to change that clause by market regulator Consob.

Two members of the Ligresti family, which controls Fondiaria through its parent Premafin, said on Friday they would not accept a condition waiving protection from legal action to former managers at Fondiaria. They cited continual changes with the Unipol offer and doubts over its financial strength for their decision.

The move increases the likelihood that Fondiaria is put under court-appointed administration.

A source familiar with the situation said Mediobanca's loans to Fondiaria would remain performing, even under this extreme scenario, and that this would increase the likelihood of a merger with Unipol, the only industrial partner willing to take Fondiaria on.

The two Ligrestis each own 10 percent of Premafin which in turn holds 35.7 percent of Fondiaria.

At 0851 GMT Fondiaria shares were up 11 percent after a brief suspension for excessive gains. Unipol shares were up 0.95 percent and Mediobanca was down 4 percent. ($1 = 0.7960 euros)

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