As world powers failed to agree on a common line on Libya, Gaddafi's troops inflicted heavy bombardment on the rebel-held Ajdabiyah, the last town before Benghazi.
However, the outgunned rebel fighters denied claims that the area had been recaptured by government troops, the BBC reported.
The fall Ajdabiya, which is 160km west of Benghazi, in the hands of Gaddafi's troops will clear a possible attack on capital of the rebels.
Pro-Gaddafi forces were also reported to be shelling Misrata, the only western city held by the rebels.
In an address to a select gathering of his supporters last night, a defiant Gaddafi warned that Libyans would fight to the death to defend their country as he called upon his people to take up arms against a possible invasion by western powers.
Describing the rebels as "rats", Gaddafi slammed Western nations. "They want Libyan oil," he was quoted as saying by Al-Jazeera channel.
"France now raises its head and says that it will strike Libya," Gaddafi told the gathering at his fortified Bab al-Azizia compound in central Tripoli.
"Strike Libya?" he asked. "We'll be the one who strikes you! We struck you in Algeria, in Vietnam. You want to strike us? Come and give it a try."
The defiant stand of Gaddafi came as the UN Security Council was set to discuss a draft resolution on imposing a no-fly zone over Libya in a bid to ground his aircraft that has been pounding the rebels.
The text of the draft resolution, co-authored by Britain and France, was circulated at the UN Security Council by Lebanon yesterday, but other countries in the body were still not completely on board.
On Saturday last, the Arab League called for a no-fly zone to be imposed over Libya but questions had been raised about the implementation of this measure, including where will the assets for this step come from.