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They clearly already had space, so that excuse is out.
To play devil's advocate here:
It's hypothetically possible they didn't. If the school is required to enroll every student in its district regardless of its capacity, the school could have been overcrowded already. Kicking out two students may still have left them overcrowded and thus given them justification to deny their admittance on residency status.
(To be absolutely clear, I don't think this is what happened, but it's also not an impossible scenario either. But as the school won't comment now that there's pending litigation we only have the mother's word as to what happened, and even though we have no reason to not believe what she is claiming, it should still be remembered that you can allege pretty much whatever you want when filing a civil suit.)