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BLOOR v. FALSTAFF BREWING CORP.

July 6, 1978

James BLOOR, as Reorganization Trustee of Balco Properties Corporation, Plaintiff,
v.
FALSTAFF BREWING CORPORATION, Defendant


Brieant, J.


The opinion of the court was delivered by: BRIEANT

FINDINGS AND CONCLUSIONS

Brieant, J.

 This action was filed July 21, 1976 to recover monetary damages for breach of contract. Plaintiff James Bloor is the Reorganization Trustee of Balco Properties Corporation, formerly named P. Ballantine & Sons ("Ballantine"). Defendant is the Falstaff Brewing Corporation ("Falstaff"), which on March 31, 1972 bought from Investors Funding Corporation ("IFC") the Ballantine brewing labels, trademarks, accounts receivable, distribution systems and other property, excepting only the Ballantine brewery.

 The purchase agreement called for an immediate payment to Ballantine of $4,000,000.00 and royalty payments thereafter of $.50 to be paid on each barrel (31 gallons) of the Ballantine brands sold between April 1, 1972 and March 31, 1978. The contract contained a liquidated damages clause, calling for payments of $1,100,000.00 a year which were to be made in the event Falstaff "substantially discontinue[d] the distribution of beer under the brand name 'Ballantine'." The contract also required that Falstaff "use its best efforts to promote and maintain a high volume of sales" of the Ballantine brands.

 This action arises out of defendant's alleged breach of these covenants by its substantial discontinuance of the Ballantine brands or its failure to use best efforts in their promotion, and also by its failure to pay any royalties whatsoever on sales of those brands after December 1975, and by its alleged underpayment of royalties before that date.

 The contract is integrated and provides that it "shall be governed by and construed and enforced in accordance with the laws of the State of New York."

 Defendant Falstaff has in turn counterclaimed against the plaintiff, alleging (1) a shortage in the cooperage (beer barrels, now universally made of aluminum) purchased from Ballantine: (2) the illegality and consequent uncollectibility of one of the accounts receivable purchased from Ballantine; (3) the invalidity of Ballantine's claimed ownership of the brand name "Munich"; (4) the moldiness and infestation of eleven carloads of bulk corn grits purchased from Ballantine as a part of the acquired inventory; and (5) Ballantine's fraudulent inducement and misrepresentation in the making of the original contract.

 Jurisdiction in this action is founded on the diversity of citizenship of the parties, and is proper under 28 U.S.C. ยง 1331. Falstaff is a Delaware corporation, with its principal place of business in San Francisco, California; Balco Properties Corporation is a New Jersey corporation, with its principal place of business in New York City.

 Trial was held before the Court without a jury on December 12, 13, 15, 19, 20 and 27, 1977. The post-trial briefs and submissions of the parties have been read and considered.

 Beer

 Some preliminary discussion of brewing, the brewing industry in America and some of its current vicissitudes, is essential to a proper understanding of this case.

 Generically speaking, "beer" is the name given any alcoholic beverage made by the fermentation of extracts of various starchy materials, usually grains. The process was known, and was apparently independently developed, in ancient Babylon, Egypt and China, as well as in South Africa, where the Kaffirs made a species of beer from millet. In the Near East, barley was apparently the original grain used for beer. It was buried in pots to allow it to germinate ("malting") and then mixed with water and allowed to ferment through the action of air-borne yeasts. In essence the same process is still used today. All ancient beers contained various herbs to relieve the flatness and sweetness of simple beer. The use of hops for this purpose dates from the 10th century B.C., and is now almost universal. In English-speaking countries the presence or absence of hops originally distinguished beer from ale, *fn1" but both products now contain hops, and the term "ale" now merely denotes a product with a heartier and more robust flavor.

 The Domesday Book (1086) records the existence of some forty-three cerevisarii (brewers) then found in England, but the distribution of a brewer's products nationally or internationally is largely a twentieth century, and in the United States specifically a post-World War II, phenomenon. *fn2" On the trial of this matter, experts testified that it was the exposure of American servicemen and women to the beers produced by the larger breweries under contract to the armed services that began the trend away from the many small, local or regional brewers, each of whom made their own beer with distinctive flavor, towards the few national brewers who produce beers essentially indistinguishable in taste and body.

 The biggest single factor contributing to the decline of local and regional brewers has been the enormous market growth, with its consequent efficiency and economy of scale, recently experienced by the "nationals": Miller's, Schlitz, Anheuser-Busch, Coors and Pabst, with Pabst now holding only a precarious position relative to the other four. Although beer consumption in the United States has been rising at approximately 4% per year, the "nationals" have increased their sales by an average of 12% per year, with the difference coming largely out of the sales of the smaller, local and regional brewers. From 1956 to 1966 the nationals expanded their production capacity by some 5.5 million barrels; from 1966 to 1976 they expanded their capacity by more than 75 million barrels and each year produced beer at almost the full capacity constructed the previous year. The cost-effectiveness of full production is obvious, especially in light of the fact, testified to by Mr. Paul Kalmanovitz, Chairman of the Board of Falstaff, that the cost of the ingredients in any two brands of domestic beer is exactly the same, with the exception of coloring materials which might add 2 cents to the cost of a case of beer. It is estimated that by 1980 the nationals will have 80% of the beer market in the United States, a 24% increase over the share held in 1976.

 There was expert testimony at trial concerning "general discussion" in the beer industry of the "predatory pricing practices" of the national brewers, although no formal court action has yet been filed against them. It was suggested that several of the nationals may have sold their product in areas, or generally, at a loss for extended periods in order to broaden their market and drive out competition. There is knowledgeable suspicion that some national brewers may have operated their entire malt beverage operations at a loss for these same purposes, while being supported by income from other operations. It is uncontested that the increases in the retail price of beer during the last ten years have lagged considerably behind rises in the cost of its ingredients and the labor to manufacture it.

 Advertising has also been a major factor in the growth of the nationals and the decline of local or regional breweries. It was undisputed at trial that, except for "ales" generally and excluding a very few distinctive smaller brews such as Rolling Rock Beer (produced by Latrobe Brewing Co. in Pennsylvania) and Anchor Steam Beer, made in San Francisco since the Gold Rush, all beers appear to be relatively indistinguishable in taste for the average customer. "Image" apparently sells beer, the image of the beer in the marketplace, and the image projected by advertising, of the typical consumer of that brand. *fn3"

 In 1961 it became lawful for the major sports teams to combine to sell network television rights to their games. In an event, such as Monday Night Football, a minute of advertising can cost approximately $100,000.00, with a typical advertising "package" for the whole event costing about $1,400,000.00. For the national brewers such advertising is efficient and inexpensive: they sell beer in the same geographic area covered by the television networks, and the cost of reaching an individual home only amounts to seven-tenths of a cent. The same cost factors make national network advertising unreasonably expensive for the local or regional brewer.

 Coupled with these economic factors have been profound changes in the American public's tastes and beer-drinking habits. At the beginning of World War II, two-thirds of the beer consumed in America was drunk in licensed premises or purchased in draft from such premises: the beer bucket was still a familiar household utensil. *fn4" Now only one-third of all beer is consumed in saloons and bars, and two-thirds is consumed at home. In addition, the taste preference of the American consumer has tended more and more towards clearer, lighter beers and away from "porters," "stouts," and distinctive heavy-flavored beverages. The phenomenal success of Coors Beer is partially attributable to Coors' lightness. In the 1960's several of the nationals, specifically Schlitz and Budweiser, reformulated their product to bring it more in line with current American tastes. Most recently, the brewing industry has been affected by a wave of "light" beers, beginning with Miller's Lite Beer. Falstaff has marketed its version, Falstaff 96 Beer, containing only 96 calories. In 1977 "light" beers accounted for about 7% of total industry production. *fn5"

 The result of all these changes, and the smaller brewers' inability or failure to keep pace with them, has been the bankruptcy or elimination from the marketplace of many smaller brewers and the decline of the market share held by the local and regional survivors. After Prohibition there were some 866 brewers in the United States. Today there are only 40. Expert testimony at trial suggested that by 1980 there would be only 5 of any importance. Western New York provides in microcosm a view of the whole industry. In the 1890's there were 32 local breweries in Buffalo alone; today only the Fred Koch Brewery ("The Tiny Little Brewery Where Real Beer Is Made") remains in the whole area, and it is the nation's second smallest brewer, holding only five-tenths of 1 percent of the American beer market. The smallest producer is San Francisco's unique Anchor Steam Beer. Mr. Kalmanovitz testified that at the time of trial one of his breweries was the only independent brewer left in the State of California.

 The result of all these changes in the industry has been to compel the smaller brewers to combine in order to produce beer at near capacity levels in one brewery, rather than at a fraction of capacity in several inefficient breweries. Also, as Robert T. Colson, Executive Vice-President of Falstaff testified, "the brewing industry in the late '60's and early '70's was a hotbed of price promotions," (Plaintiff's Ex. 115, at p. 114), as brewers scrambled for a piece of the declining market share held by regionals, and cut prices to do so.

 Ballantine and Falstaff

 For the first half-century of its existence, P. Ballantine & Sons was a family owned operation, producing generally for the northeast market. In the early 1970's, the "tristate" area of New York, New Jersey, Connecticut and Pennsylvania accounted for approximately half of its sales. Its principal products were Ballantine Beer, Ballantine Ale, Ballantine India Pale Ale and Munich Beer. Ballantine Beer is primarily a "price" beer, the term used in the brewing industry to distinguish low-priced beers from middle-range or high-priced "premium" beers. The distinction is based on price and "image" rather than on any inherent difference in quality. Ballantine's sales declined from 1961 on, and the company lost money from 1965 on.

 On June 1, 1969, Investors Funding Corporation, a New York based real estate conglomerate having no prior experience in the brewing industry, acquired substantially all of the capital stock of Ballantine for $16,290,000.00. *fn6" In the first two years of its ownership, IFC increased advertising expenditures significantly, levelling off its advertising budget in 1971 at approximately $1 Million a year. Although its period of ownership coincided with the entry of the nationals into the northeast market, the largest beer consumption area in the country, IFC managed to increase its sales of Ballantine products during each month it held the company. Despite this apparent "success," Ballantine never turned a profit for IFC, and during the first three months of 1972, immediately before Falstaff's acquisition of the company, was losing approximately $1 Million a month. During the whole period 1969-1972, the Ballantine Brewery in Newark, New Jersey was producing at only about 50% of its five-million barrel capacity.

 IFC used two methods to distribute the Ballantine products. The first was the normal method in the industry, sales at wholesale to independent distributors. Ballantine also, however, sold beer directly to smaller accounts ("Mom and Pop stores," bars, and the like), using its own warehouses and trucks. In the New York area this "retail" operation in 1972 was servicing some 25,000 accounts directly from the Ballantine brewery in Newark, New Jersey.

 In the early 1960's, Falstaff Brewing Company was the nation's fourth largest brewer, although its distribution was primarily in the West and Midwest. In 1964 it embarked upon a ten year program to enter the ranks of the "national" brewers. As part of this expansion, Falstaff in 1965 acquired the Narragansett Brewing Company, at the time the largest producer of beer in New England. See, United States v. Falstaff, 410 U.S. 526, 35 L. Ed. 2d 475, 93 S. Ct. 1096 (1973) and 383 F. Supp. 1020 (D. R.I. 1974).

 By contract dated March 3, 1972, Falstaff acquired Ballantine's assets. The closing took place on March 31, 1972. At that time Falstaff was the fifth ranking brewer in the United States but had failed to acquire a substantial foothold in New York, New Jersey and Pennsylvania, the highest beer consuming region in the country. Its purchase of Ballantine was apparently prompted by the desire to acquire a ready-made distribution system in the New York area, and by its need to utilize the excess capacity of its own breweries. Falstaff did not buy the Ballantine brewery in Newark, New Jersey. At some undetermined date during its ownership of Ballantine, Falstaff began using its own beer, without formula alteration, to fill Ballantine Beer containers. At the present time, the only difference between Ballantine and Falstaff Beer is the label. Falstaff was also motivated in its purchase by the fact that Ballantine Beer was (and is) a "price" beer in the Northeast and would in the normal course of events not compete with Falstaff's own so-called "premium" beer.

 Shortly after acquiring the Ballantine assets, Falstaff moved the "retail" distribution operation from Newark, New Jersey (the location of the Ballantine brewery) to North Bergen, New Jersey, where it continued until 1975 to service generally the same accounts. Between 1972 and 1975, Falstaff also continued the former policy of substantial advertising of Ballantine products, spending more than $1 Million a year for that purpose. Falstaff continued in every way the former pricing policies used by IFC, including substantial " post-offs" from listed prices. During this period, Falstaff claims to have lost $22 Million in its Ballantine brands operations.

 A very significant change in the modus operandi of Falstaff-Ballantine took place in 1975. In March of that year, Mr. Paul Kalmanovitz, an entrepreneur with 40 years experience in the brewing industry who had owned a small position in Falstaff stock prior to that time, advanced $3 Million to Falstaff to enable it to meet its payroll and other pressing debts then due. On March 10, 1975, in return for some $10 Million cash advanced, and additional loan guaranties, Mr. Kalmanovitz was issued new convertible preferred shares in amounts equal to about 35% of the company's outstanding shares. A voting trust arrangement was made to give him control of the Board of Directors. The shareholders of Falstaff approved the agreement on April 28, 1975. At present, Mr. Kalmanovitz is Chairman of the Board of Falstaff.

 Mr. Kalmanovitz is a highly individualistic entrepreneur in the highest tradition of the old school. He has built and owned several television studios, including the first ABC studio in California, and owns several advertising agencies. His experience in the brewing industry began in 1935, when he began to purchase the 27 nightclubs and restaurants he eventually came to own in California. His acquisition of breweries began in 1950, and at different times he has bought 17 of them, including Regal Pale Brewing Company, Maier Brewing Company, Walter Brewing Company, Grace Brewing Company, Goebel Brewing Company and General Brewing Company (the California producer of Lucky Lager Beer). In January 1978, he acquired the Pearl Brewing Company of San Antonio, Texas.

 Although he is now 72 years old, Mr. Kalmanovitz testified convincingly to his drive to keep active and specifically to his desire to attempt to set aside what he called "the Coors' timetable" (Tr. p. 699). This is a reference to the estimate of Mr. William K. Coors, President of Coors Brewing Company, that by 1980 there would be only five brewers left in the United States. Mr. Kalmanovitz's philosophy in attempting this task is simple:

 
"So I have a firm opinion that profit is not a dirty word. Profit is a better product at lower cost to the consumer, and [is] employment . . . ." (Tr. p. 667).

 The message conveyed to his distributors is equally simple:

 
"'Just buy our product and sell it and make a profit.' That's my philosophy. It has been successful because I am still here as an independent brewery." (Tr. pp. 670-71).

 Since Mr. Kalmanovitz's assumption of control of Falstaff the advertising budget for Ballantine products has decreased from about $1 Million a year to a point near non-existence (about $115,000.00 since the beginning of 1976). Substantial cuts have also been made in sales and management personnel. In late 1975 four of the six "retail" distribution centers, including the North Bergen depot, were substantially closed or phased out. The North Bergen depot was replaced by two independent distributors who together service substantially fewer accounts. In mid-1976 Mr. Kalmanovitz also discontinued the price cutting policies of former management, ordering that no beer was to be "given away" in the future.

 Concomitant with these changes, and, plaintiff argues, causally related to them, there has been a precipitous decline in the sales of Ballantine products, and a slightly less precipitous diminuition in the sale of Falstaff products. In December 1975, Falstaff unilaterally discontinued royalty payments on sales of Ballantine products.

 After selling its brewery assets in March 1972, Balco Properties Corporation attempted to convert the Newark Industrial and Office Plaza, the site of the brewery, into an industrial park. Financially, the attempt was unsuccessful, and in October 1974 both Balco and its parent corporation, IFC, filed petitions for voluntary reorganization under Chapter X of the bankruptcy laws. See, Memorandum Opinion of Judge Bonsal of this Court, dated December 21, 1977, In the Matter of Investors Funding Corporation of New York, Balco Properties Corporation, Dkt. No. 74 B 1454, familiarity with which is assumed.

 Plaintiff's Claims Pleaded

 Plaintiff is suing to recover money damages for Falstaff's breach of contract in three separate instances: (1) Falstaff's "substantial discontinuance" of distribution of Ballantine products, or its failure to use best efforts to keep sales of them high; (2) Falstaff's underpayment of royalties prior to December 1975; and (3) Falstaff's discontinuance of royalty payments on Ballantine products sold after December 1975. We consider these claims separately.

 After the trial of this action, plaintiff abandoned all claims for substantial discontinuance and lack of best efforts for the period before May 1975 (the date Mr. Kalmanovitz assumed operating control of Falstaff).

 The relevant portions of the contract on which plaintiff relies are as follows:

 
"8. Certain Other Covenants of Buyer. (a) After the Closing Date the [Buyer] will use its best efforts to promote and maintain a high volume of sales under the Proprietary Rights."
 
"2(a)(v) [The Buyer will pay a royalty of $.50 per barrel for a period of 6 years], provided, however that if during the Royalty Period the Buyer substantially discontinues the distribution of beer under the brand name 'Ballantine' (except as the result of a restraining order in effect for 30 days issued by a court of competent jurisdiction at the request of a governmental authority), it will pay to the Seller a cash sum equal to the years and fraction thereof remaining in the Royalty Period times $1,100,000, payable in equal monthly ...

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