Troubleshoot hook_library_alter() not being called for the jQuery Update module
I had this problem as well and I tracked it down to a custom module calling drupal_add_js() right at the top of the module file. This meant that drupal_get_library(system, jquery) and in turn module_implements(library_alter) were getting called before the jquery_update.module file had a chance to get loaded and hence jquery_update_library_alter wasn't defined yet.

To find this I put the following lines into drupal/include/module.inc and cleared the cache.

...
function module_implements($hook, $sort = FALSE, $reset = FALSE) {
    if ($hook == 'library_alter') { debug_print_backtrace(); exit; }
...


You might have some other problem, but a call to drupal_add_js to early in execution was my issue.