This paper investigates the problem of simultaneous state and fault estimation and observer-based fault tolerant controller design for Lipschitz nonlinear systems with sensor failure. A new estimation technique is presented in this paper to deal with this design problem. In the proposed approaches, the original system is first augmented by a descriptor model transformation, then a new Proportional and Derivative sliding mode observer technique is developed to obtain accurate estimations of both system states and sensor faults. The designing observer is generalized from the PD observer in [3], but is not a trivial extension. Based on the state estimates, a observer-based control strategy is developed to stabilize the resulting closed-loop system. Finally, a numerical example is presented to illustrate the effectiveness and applicability of the proposed technique.