Big problem but possibly not a total write off.
The T&C clause is pretty clear but is specifically refering to the airline - you can't change the flight ticket or have a refund for it at this stage. But the accomodation is still there, paid for and usable. Since you are lead name you could go alone if you can't get the other friend to join you.
There are two options for the other friend but it could be too late for either.
The obvious one is hinted at in the clause - you pay for a new flight ticket on your booked flight. This might not be possible if the flight is full on the system (even though you first friend won't be turning up it's probably too late to change the system). Or it may be on a flight where individual tickets can't be bought. And it may cost more than the whole holiday did originally! You need to see the agent about this but before you go you need to do some urgent research on the internet about the second option!
The second option is less attractive but needs to be checked first. Can you get any flight from an airline or flight only agent on the same dates and if so how much? If that is signficantly cheaper than going on the original flight or if the original can't be booked it may be possible for the second friend to travel seperately and meet you there.
This will lead to the question of the first friends money. We've had this problem before and the general view was as follows.
If he cancels this late and isn't replaced the tour op will not refund so he gets nothing. Simple.
If you both cancel neither will get a refund. Unlikely your insurance would cover you, although it might if he was ill or had been burgled etc.
If you go and he is replaced he might claim the value of what he paid for what was used by someone else. Clearly this won't be the flight element. If he does claim, deduct whatever the new flight costs from the total of what he originally paid - that would be a fair offer even though it is likely to be a lot less than the accomodation element of the original price. Actually it would be fair to also deduct a little extra for your time and stress!