When Zan noticed the smoke, his cat was lying on his papers. The reason why the correct answer is option 'C' is because of the context clues given in the question. Let's break down the possible options and analyze why they are incorrect:

a) Running around the house: This option does not align with the fact that Zan noticed the smoke. If the cat was running around the house, it is unlikely that Zan would have noticed the smoke while the cat was engaged in such an activity. Therefore, this option is incorrect.

b) Sleeping in her basket: Similar to the previous option, if the cat was peacefully sleeping in her basket, it is unlikely that Zan would have noticed the smoke. This option does not fit the given context, so it is also incorrect.

d) Scratching the furniture: While it is possible for a cat to scratch the furniture, this option does not provide any indication that Zan noticed the smoke. It is not directly related to the situation at hand, so this option is also incorrect.

Now, let's analyze why option 'C' is correct:

c) Lying on his papers: This option aligns with the context given in the question. If the cat was lying on Zan's papers, it suggests that Zan was present in the room and working on something. This would explain why he noticed the smoke. Additionally, the act of lying on the papers implies that the cat was not engaged in any other activities that would distract Zan from noticing the smoke. Therefore, option 'C' is the most logical answer.

In conclusion, when Zan noticed the smoke, his cat was lying on his papers. The other options do not fit the given context and do not provide a plausible explanation for Zan's awareness of the smoke.