After coming across the Mortal Kombat: Shaolin Monks 2 image posted on the personal website of former Midway LA employee Matthew Doyle, I decided to contact Matt to see if he had anymore information about the game. According to Matt, the game was codenamed 'Fire and Ice' due to Scorpion and Sub-Zero being the planned main characters.

Matthew Doyle: It was canceled within a few weeks of my arriving at Midway. I don't have anything else to show you unfortunately. Half the studio was laid off, and new management was brought in. Then we started work on TNA Wrestling.

A prototype level was built, but that was it. A few design docs were worked on, and a few characters were made in 3D - Scorpion and Subzero. The game was codenamed Fire & Ice - as those two characters were to be the main characters. I was really looking forward to doing level design and construction for it. It was a shame it was canceled.

Not sure how Scorpion and Sub-Zero working as a team would work canon-wise. It sounds like it would've really screwed up continuity, assuming the game's storyline took place right after the first Shaolin Monks game. Oh well, maybe it's cancellation was for the best.