Fat Albert and his friends are rehearsing in their junkyard clubhouse for a Christmas pageant that they want to put on for their families. The junkyard's owner, "Old Tightwad" Tyrone shows up and threatens to kick them all out by midnight so he can bulldoze their clubhouse to the ground. After he leaves, the guys are worried about losing their favorite hangout spot, when a little boy named Marshall knocks on the door, looking for help. His parents are in big trouble. They came to town so his dad Ray could get a job, but it fell through, so they are homeless, and his mom Marge is pregnant and having labor pains. The guys try to help them. Turned away from the nearby hospital because they have no insurance, they are told to go the city hospital as a charity case, but it is too far away.
Fat Albert strikes a deal with Tyrone to save the clubhouse. He works at Tyrone's store, giving away small gifts to entice customers to come in and shop. Things are going very well, until his friends show up, and think he has become a traitor. When he explains the deal, they all begin to grab for free gifts, angering Tyrone, who kicks them all out and says the clubhouse will come down anyway. Mudfoot Brown arrives to give Tyrone what-for,saying what his late wife Martha would do if she saw him acting like that and Tyrone admits to him and Fat Albert that he has been lonely, bitter and miserable since his wife Martha past away. Mudfoot warns him that he needs to change his ways.
In the ruckus, little Marshall slips away unnoticed. He heads back to the clubhouse, where he overhears Ray say in discouragement that he does not know how he will ever be able to take care of everyone. Marshall decides to run away to spare his dad the trouble and befriended a starving dog who was trying to get a bone from a trash can. When they realize he is missing, the guys search everywhere for him. Marge is ready to have the baby, so they also get Doc Brown to come to the clubhouse. Fat Albert have to save Marshall from falling into the icy river when he tries to get away from him , but after rescuing him, he still runs away again afterward.
Dejected Fat Albert decides to go back to the clubhouse where after hearing a baby's cry coming from the clubhouse and find the baby has come with the rest of the gang and Doc Brown present at the baby's birth and then Tyrone himself shows up, with Marshall. Russell begs him not to throw the family out in the snow, but Tyrone tells them all he has had a change of heart. He will try to help Ray find a job and take the family to a good hospital. He also will not tear down the guys' clubhouse, as it has become a 'landmark' with the baby's birth so near to Christmas. Tyrone looks up at the night sky, smiling as he asks for Martha's approval of his change of heart.
- The incidental music used in The Fat Albert Christmas Special was also used in the Filmation animated feature Oliver Twist.