Fighters have moved on Bani Walid from three sides, warning Gaddafi loyalists to surrender or be attacked.
The desert town hit the headlines last month as rumours spread that two of Col Gaddafi's sons had travelled through it as they fled south from Tripoli.
Some reports say Gaddafi family members may still be in the town.
On Saturday, the head of Libya's interim governing NTC said its soldiers were also laying siege to Col Gaddafi's birthplace in Sirte, as well as Jufra and Sabha.
National Transitional Council Chairman Mustafa Abdel Jalil said the towns were being given humanitarian aid, but had one week to surrender "to avoid further bloodshed".
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