The first U.S. Circuit Court of Appeals this week declared unconstitutional a Massachusetts law that had allowed the Holy Cross Armenian Catholic Church in Harvard Square to block Grendel's Den restaurant from obtaining a liquor license.

The law, passed in 1933 at the end of Prohibition, gives churches and schools the right to veto the issuing of liquor licenses to premises within 500 feet of their premises.

Writing the circuit court's 2-1 decision to strike down the law. Chief Justice Frank M. Coffin wrote Tuesday that the statute "has a primary or principal effect of advancing religion," and was hence in conflict with the First Amendment.

The statute was originally struck down earlier this year at the federal district level, only to be reaffirmed last November by the same Circuit Court of Appeals.

David H. Remes an assistant to Harvard Law professor Laurence H. Tribe, the attorney for Grendel's, said yesterday the court's decision to re-hear the case was "extraordinary."

"When they handed down their original decision in April, they pretty much misunderstood the danger we were warning about," Remes said.

The court had originally been afraid that overturning the law might infringe on the state's right to create liquor-free zones, Remes said.

Tribe was more concerned that the law gave a church the right to threaten the viability of an established commercial enterprise without giving a reason for its decision, Remes added.

"This was a serious infringement of due process," Remes said. Twenty-six other restaurants within 500 feet of the church already have liquor licenses, and Grendel's in the only establishment that the church has consistently opposed.

Calling the decision "very exciting." Herbert Kuelzer, the owner of Grendel's Den, said that as yet he has not consulted with his attorney to see when or if he will apply for a license.

"It still depends on whether the state or the church appeal," the decision, Kuelzer said, adding that if an appeal does go through, the case will go to the United States Supreme Court.

Kuelzer, who began the suit when he purchased the restaurant in 1970, said further that the issuance of a license would most likely increase his business. Patrons are currently allowed to bring their own liquor into the restaurant, but "that doesn't do much good for the people who want a martini with lunch," he said.

The Rev. Peter Conley, spokesman for the Roman Catholic Archdiocese of Boston, said "the initial reaction to the veto was disapointment. The law has worked well in the past," he said, although he added that the case was not the most pressing one facing the archdiocese.

"Nobody's going to bleed at that barricade," Conley added.

The Circuit Court of Appeals decision to overturn the law holds precedence over the court's April decision because the latest ruling was made "en banc," or from the full court. The process is only considered necessary. Remes said, when the court finds the error in the law "egregious enough to warrant correction before it gets to the Supreme Court."

Remes said the "en banc" process was very unusual. Of the 3000 petitions filed every year for a full hearing "en banc," only about 60 are accepted to be heard by the court.

"It is hard to predict what the state will do next," Remes said, although Kuezler speculated that if the case is appealed to the Supreme Court, it would most likely be heard sometime next February with a decision handed down in May or June.

Kuezler said the case would have cost him nearly $150.000 had not his lawyers been working without pay. He said he may try to recover damages once the case is over.

John Larkin, chairman of the state Alcoholic Beverages Control Commission said it would be impossible to determine how many restaurants will be affected by the new ruling.

According to the Commission, the law allowing the church and school veto has been on the books since 1933. It was drafted to placate the Women's Christian Temperance Union and other prohibitionist groups as America's experiment with a liquor-less state came to a close, one commission member said.