I only have anecdotal evidence for what I'm going to say because I remember someone else doing this a few years ago with the same problem.
She sent in a letter with the application stating that her mother's passport no longer existed, or was lost, or that they were estranged! (I don't remember exactly anymore) It was not a problem.
In my own case, my mother's last UK passport is no longer in existence as far as either she or I know...it's been expired for years and she never applied for another one because she thought she was no longer a UK citizen once she took on American citizenship. Also, she wouldn't let me have it even if she had it available to her because she thinks I'm crazy for wanting to become a dual citizen! When I apply, I haven't quite decided how I'm going to state all this.

Will probably keep it as simple as the first truth - that it is no longer in existence.
Hope that helps a little bit. I find it interesting that they ask for the expired passport. In all likelihood, a lot of those British moms would still have an up-to-date British passport...