This paper focuses the development of an adaptive observer-based distributed fault estimation observer (DFEO) for multi-agent nonlinear time-delay systems under a directed communication topology. The process involves constructing a fault estimation observer for each agent based on their relative output estimation errors. An adaptive DFEO design is proposed for multi-agent systems with a directed communication topology. Furthermore, investigating the effect of faulty agents on the criteria of fault detection on healthy agents. The proposed design is represented with Linear Matrix Inequalities (LMIs) to establish a systematic design procedure. The study also includes simulation results to demonstrate the effectiveness of the proposed design techniques.