After further testing: the DevForce 5.1.1 Silverlight template application "Hello DevForce" will compile using Sl3 sdk assemblies. The ClientBin folder of the web application does not automatically receive the client xap file for some reason. It's the same with the standard visual studio silverlight template too. For some reason, the client sl application does not automatically copy and/or refresh its version in the web application's ClientBin directory. Hence, web app cannot find it to download and run, therefore the above error.
A manual copy of the xap file for either DevForce hello world app or VS standard silverlight app to the webapp's ClientBin directory overcomes this issue.
For now I have set the build output directory of the SL app to be the ClientBin folder of the web app. I'm not sure if this is the correct practice or not, but at least for now it means I can compile and test application without manually copying the xap file each time.
I'm wondering whether an app setting somewhere controls this...?
Rgds
bigfish