Libya and families of the 1988 Lockerbie bombing victims agreed on Wednesday to set up a $2.7 billion compensation account in a key step toward closing the book on the mid-air airliner explosion that killed 270 people and further poisoned Libya's relations with the West.

Scottish rescue workers and crash investigators search the area around the cockpit of Pan Am flight 103 in a farmer's field east of Lockerbie Scotland on December 23, 1988. [Reuters]

Lawyers for the families said they and Libyan officials signed the agreement in London after an 11-hour meeting. Libya was expected to follow up by sending a letter to the U.N. Security Council on Thursday or Friday taking responsibility for the bombing of Pan Am Flight 103 over Lockerbie, Scotland.

The Libyan admission of guilt -- long demanded by the United States and Britain -- and the actual payment of the $2.7 billion were expected to be followed by moves to lift U.N. sanctions against Libya, possibly as early as next week.

Diplomats stressed the matter will not be settled until Libya admits responsibility in writing -- something it has long been loathe to do -- and pays the compensation, which could ultimately reach $10 million per victim.

U.S. sanctions will stay in place for now despite U.S. oil companies' eagerness to do business with Tripoli again, U.S. officials said. Some U.S. sanctions predate Lockerbie and reflect Washington's long-standing anger at what it views as Libyan support for acts like the 1986 bombing of a Berlin disco that triggered U.S. airstrikes on Libya.

"Libya and the lawyers representing families of the victims have signed an agreement to create the escrow account at the Bank for International Settlements," British-based Algerian lawyer Saad Djebbar, who has followed the case since 1992, told Reuters from London.

"I expect that by the middle of next week U.N. sanctions will have been finally removed on Libya," Djebbar said.

"Great news. After an 11-hour session in London today, we signed an Escrow Agreement with the Libyan delegation and the Bank (for) International Settlements," Jim Kreindler, a U.S. attorney for many families, wrote in a letter to his clients, saying he expected the $2.7 billion to be deposited "soon."

Some relatives of the 259 people who were killed aboard the Boeing jumbo jet and the 11 people who died on the ground reacted bitterly at what they described as the first step toward Libya being welcomed back into the world community.

"AN UNFORGIVABLE ACT"

"Obviously we're not happy. We feel this may be the first step in the rehabilitation of (Libyan leader) Muammar Gaddafi," said Dan Cohen of New Jersey, whose 20-year-old daughter Theodora died in the bombing.

Stephanie Bernstein of Maryland, whose husband Michael died at the age of 36, said she wanted to wait until she saw the Libyan statement accepting blame, which the State Department is expected to describe to the families at a briefing in Washington scheduled for noon on Friday.

"For me that is the most important thing. Gaddafi being Gaddafi, this could all fall apart," Bernstein said.

Libya agreed in March on the language about taking responsibility and confirmed it on Monday in talks with U.S. and British officials. The United States and Britain have declined to release the phrasing or to confirm that the families and Libya signed an agreement on Wednesday.

Many of the family members feel deeply ambivalent about compensation payments, saying nothing can replace their loved ones and demanding that Libya continue to be punished for the bombing through U.S. sanctions.

Under the deal between the families and Libyan officials, Libya could pay up to $10 million in compensation for each of the 270 victims that may be covered by the settlement.

An initial $4 million would be paid once U.N. sanctions, which were imposed on Libya in 1992 and suspended in 1999 after Tripoli turned over two Libyan suspects for trial, are ended. One Libyan suspect was convicted and the other acquitted in 2001 after a trial in the Netherlands under Scottish law.

The first payment would be followed by another $4 million if the United States lifts its own sanctions and by $2 million if it drops Libya from the U.S. list of state sponsors of terrorism.

If Washington does not take these steps within eight months of Libya placing the $2.7 billion into the escrow account, the victims' families would receive only $1 million more, bringing the total compensation to $5 million per victim. The remaining money would then revert to Libya.

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